Currencies | Aug 26 2010
By Chris Shaw
The Japanese yen has appreciated in recent weeks against the US dollar in particular, to the extent the US currency has now hit a 15-year low against the yen. The move has been significant enough for Danske Bank to expect some action by the Bank of Japan (BoJ) to stem the rise in the Japanese currency.
Danske Bank doesn't expect any direct intervention in foreign exchange markets, though this remains a possibility, but it does see the BoJ stepping up the pace of its quantitative easing program. Most likely is action in a manner similar to that done in December of last year when the yen was also strengthening and so threatening the health of the Japanese economy.
Intervention appears imminent for three reasons, reports Danske Bank, the first being the yen rate against the US dollar has now appreciated above the levels of last December when the BoJ attempted to draw a line in the sand against further gains.
As well, both the Japanese and the global economies appear more fragile now than was the case last December. Danske Bank sees scope for the BoJ to downgrade its view of the Japanese economy when the central bankers next meet early in September.
Finally, there is pressure on the BoJ to be seen to be doing something about the strength in the yen, with both major political parties in Japan arguing for changes in Bank of Japan laws to force some action. One possible outcome is the introduction of some sort of inflation target.
The reason direct foreign exchange market intervention is unlikely in Danske Bank's view is both the Japanese finance ministry and the BoJ don't see such intervention as being successful unless it is coordinated with major G20 partners.
While the Japanese are expected to argue the case for intervention at G20 meetings later in the year, Danske Bank doesn't see other members offering any great support for such a move. This is because from a long-term view the yen is not particularly overvalued at current levels, while Danske Bank also notes the G20 has an agreement seeking to avoid competitive devaluations in member currencies.
This leaves quantitative easing as the BoJ's main weapon, with Danske Bank expecting an increase in the size and duration of the 20 trillion yen credit facility introduced at the end of last year. Such a move should mitigate the recent yen appreciation stemming from recent drops in US money market rates.
The credit facility currently offers credit for three months at a rate of 0.1%, but Danske Bank suggests by extending the facility to six months or expanding its size this could bring money market rates down even lower.
The BoJ could also consider the purchase of Japanese government bonds, though given they are already yielding less than 1.0% at present Danske Bank sees such a move as less likely to prove effective. Any such quantitative easing measures are likely to be introduced by September 7th, as this is when the next BoJ monetary meeting concludes.
Will the moves work? Danske Bank notes the BoJ had some success when it turned to quantitative easing last December, though this time any weakening of the yen is likely to be more difficult given revised expectations for monetary policy for the likes of the US and Europe in recent months.
One positive is the market is speculative long the yen at present, so any surprise move could see some short-covering and so push cross rates in the direction the BoJ wants them to move. But for a significant movement Danske Bank suggests the BoJ will need to move very aggressively and this is not in its usual character.
As a result, Danske Bank suggests for as long as the global growth outlook remains fragile the best outcome is likely to be a stabilising in the yen rate against the US dollar between 85 to 90 yen. One other positive is any BoJ action should create something of a stronger floor for the US dollar/yen rate, which should remind the market the currency pair is unlikely to simply continue moving in one direction.
