International | Aug 30 2006
By Chris Shaw
When Japan lifted interest rates a few months ago it was seen as the start of a regular series of increases that would prove supportive for the yen, with forecasts predicting the currency would move from levels at the time of around 114 against the US dollar to well below 110 and eventually to 100.
So of course the opposite has happened, the yen having weakened in recent weeks to be trading at about 116.75 against the US dollar and even more against the euro, to a level Danske Bank estimates makes it the cheapest it has been since 1983. This cheapness is relative though as it is against the euro rather than the US dollar, the bank estimating the currency is now relatively close to fair value against the greenback.
Much of the recent weakness reflects lower than expected CPI figures, which has caused the market to scale back its expectations for future increases in interest rates in Japan. Rather than further increases this year, the consensus estimate is now for two 0.25% increases in the first half of 2007.
As a result Danske Bank has revised down its yen forecasts for the medium-term, this despite its insistence the Japanese economic recovery remains on track thanks to ongoing strength in corporate investment, a tight labour market and a solid outlook for private consumption.
It dismisses concerns over the potential impact of a slowdown in the US, in part because it doesn’t expect any slowdown to be serious and also because it views China and the US as trade partners of equal importance for the Japanese.
How then to explain the poor performance of the yen? There are a couple of contributing factors in the bank’s view, the first being with the US pausing in its rate cycle the global liquidity environment remains accommodative, which means a low yielding currency like the yen remains a good source of funding for carry trades into higher yielding currencies.
There has also in the bank’s view been a shift in the allocations of the foreign exchange reserves of some countries into the British pound and out of the yen, while the potential for further rate increases in Europe means the interest rate differential is likely to widen, making the euro more attractive in the shorter-term.
Danske is now forecasting the yen/US dollar rate to move to 119 over the next three months, before recovering slightly to 114 over the next six months and 110 this time next year. Against the euro it sees further short-term weakness to a level of about 152 over the next three months, before a similar recovery to 148 in six months and 145 a year from now.
The Danske Bank forecast of 119 in the coming months is interesting as it matches the level DBS suggests may produce some unwinding of carry trade positions. DBS agrees with the view the yen has further to fall against the US dollar in the short-term, but sees any weakness as temporary as it too sees the economic recovery in Japan as continuing.
Its short-term is far shorter than that of Danske Bank though, as it expects once the market accepts the economy continues to strengthen and deflation has indeed been beaten there will be reassessment of the expected pace of future rate hikes. This should be accompanied by measures designed to correct what it suggests is the current misalignment of the yen, which should see a reasonably strong turnaround in the currency.
DBS is forecasting a recovery to 108 against the US dollar by the end of September, with further gains to 106 by Christmas and 103 by June next year.
