International | May 09 2006
By Chris Shaw (Tokyo)
Comments by the Bank of Japan (BOJ) suggesting the Japanese recovery is now sustainable has sparked foreign exchange markets with the Yen strengthening on the expectation of a sooner than expected increase in Japanese interest rates.
The comments made by BOJ governor Toshihiko Fukui yesterday were interpreted by the market as an indication the BOJ is looking to lift official interest rates in the next couple of months, which is faster than had been expected.
Danske Bank notes there is the possibility of a 0.25% increase in official rates at the June BOJ meeting, while the market is factoring in an almost 100% chance of an increase within the next three months. This is impacting on the currency’s outlook as like the European Central Bank, the expectation is the BOJ is entering a period of higher official interest rates at the same time as the cycle of rate increases in the US is drawing to a close, a situation also emphasised by ANZ Bank as a reason for the yen’s strength.
Danske bank notes another factor in yesterday’s strength in the yen, which saw it strengthen to below 111.50 against the US dollar from more than 112 last week, were comments from US officials the Japanese should not intervene in the forex markets either physically or verbally. As the bank points out, the traditional Japanese central bank response to such comments has been to stand aside from attempting to influence the value of the currency.
Why all the fuss about the recent strength in the yen? Danske Bank notes the yen remains substantially undervalued against most currencies (as much as 25% against the Euro on the bank’s estimates), so an increase in its value would address the problem. At the same time, it would also help address some of the current global economic imbalances such as the trade advantage the Asian region is enjoying from having undervalued currencies against the US dollar and Euro.
This advantage has some speculating the BOJ will intervene if the yen strengthens too quickly, with Japan Business Federation head Hiroshi Okuda suggesting intervention was a possibility if the yen moved below 110 to the US dollar. He suggested exporters favoured a currency in the range of 110-120 against the US dollar.
Mizuho Research has estimated a stronger currency could be a negative for growth, as a sustained fall to 110 against the US dollar from 115 could cut economic growth by 0.3%, while if the currency moved to and remained at a level of around 100 to the greenback growth could fall as much as 0.8%.
JP Morgan takes a different view though, suggesting the yen remains closely pegged to the US dollar when compared to other Asian currencies, meaning the current US dollar weakness is actually making Japanese exports more competitive in the region.
From a trading perspective, the short-term outlook is for further yen strength against the US dollar particularly as Danske Bank notes the renminbi is also stronger against the greenback. The bank points out forex markets are showing net long positions in the yen for the first time since February last year, while short positions in the US dollar are increasing.
Dennis Gartman suggests this is a reflection of the unwinding of the carry trade, as those who had borrowed in yen to invest elsewhere were now short of the currency as it strengthens and so were scrambling to cover these short positions.
