It all started when Chinese President Xi Jinping, contrary to custom, did not congratulate Sanae Takaichi on her election as Prime Minister of Japan, Commerzbank's FX analyst Volkmar Baur notes.

Political tensions now driving markets

"But Takaichi certainly did not make matters better when, in response to a question in parliament, she stated that an attack on Taiwan could pose an existential threat to Japan and therefore trigger a case of self-defence. Further verbal exchanges followed, resulting in what is best described as a diplomatic ice age between the two countries. So much so that China is now advising tourists and students against travelling to Japan."

"From a currency perspective, this is interesting for two reasons. Firstly, around 20% of all tourists travelling to Japan come from China, and foreign tourists contributed around JPY 9.5 trillion to the current account surplus of JPY 31.2 trillion over the past 12 months. Assuming that half of Chinese tourists respond to the government's warning and taking into account that Chinese tourists only spend around 80% of what other tourists spend on average, Japan could lose around 800 billion in tourism revenue per year. This is not insignificant, but it does not pose a immediate threat to the JPY."

"It is more significant from a structural perspective. This incident confirms a trend that has been becoming increasingly apparent for a few years now. International politics is increasingly interfering in the markets. A single statement can be enough to divert goods or, as in this case, service flows, with an impact on the economy and currencies. Tourists are one thing. However, if the dispute continues to escalate and spreads to other service sectors and goods, the impact could be much more significant. After all, almost 20% of all Japanese goods exports still go to China. And if these are called into question, the impact could be much greater. This is therefore a risk that should be kept in mind."