The yen retreated from recent highs on Wednesday as hope Japan was poised for a shift in monetary policy evaporated.
The Bank of Japan is expected to signal the end of its five-year-old policy of quantitative easing – the pumping of excess liquidity into the banking system – in March or April.
But doubts were raised yesterday as to how much difference the policy shift will make.
Seemingly well-sourced reports in the Japanese press suggested the central bank will still cap the overnight call rate at 0.1 per cent for an extended period even after the easing policy is concluded.
Reports suggested the BoJ will continue to pump liquidity into the economy by buying Y1,200bn worth of government bonds a month to keep long-term rates capped.
“A 0.1 per cent cap on the overnight call rate could be announced in conjunction with the end of quantitative easing with the BoJ committed to supplying the necessary funds to ensure this cap is maintained,” said Derek Halpenny, senior currency economist at Bank of Tokyo-Mitsubishi UFJ. “This would help limit speculation on actual call money rate increases and reduce market turmoil, including speculative yen buying.”
Tony Norfield, global head of FX strategy at ABN Amro, argued that the collapse of Japan’s domestic money market during the years of virtually zero interest rates meant the BoJ would be forced to provide liquidity to stop rates spiking sharply higher.
Maintaining low rates would also keep the government onside by avoiding any significant rise in the cost of funding the fiscal deficit.
The likelihood of the overnight rate being held at 0.1 per cent for an “extended period”, was only one of three reasons Mr Norfield found to be bearish about the yen yesterday.
In addition, he said the scale of existing short-yen carry trade positions was only Y4,000bn, significantly less than the Y25,000bn in place in 1998 before the yen rallied from Y148 to the dollar to Y112 within two months. As such, he argues the yen would generate little upward thrust from the closure of these positions.
Thirdly, Mr Norfield cited resumption of New Zealand dollar-denominated uridashi issuance, suggesting Japanese investors were still keen to take risks to chase yield elsewhere. That in turn helped the kiwi firm 0.5 per cent to $0.6645 to the greenback.
As a result, Mr Norfield sees the yen weakening to Y118 against the US dollar in three months’ time, before firming to Y110 in a year. Similarly, Mansoor Mohi-uddin, chief FX strategist at UBS, sees the yen drifting to Y117 until easing starts to be withdrawn, before rallying towards Y110 by December.
Amid this bearish talk, the yen fell 0.3 per cent to Y116.08 against the US dollar, 0.2 per cent to Y138.22 against the euro and 0.4 per cent to Y86.28 against the Australian dollar, although it was flat at Y202.89 against sterling
The greenback reversed weakness to rally after the release of stronger-than-expected US manufacturing data.
By mid-session New York trade, the dollar was up 0.1 per cent at $1.1903 against the euro, 0.4 per cent at $1.7473 against sterling and 0.3 per cent at SFr1.3157 versus the Swiss franc.
The Chinese renminbi was allowed to edge to another post-revaluation high, rising to Rmb8.0369 to the dollar, from Rmb8.0403 on Tuesday.
The currency market was excited by a suggestion by an official at the State Administration of Foreign Exchange that China plans to open its capital account in the near term; a shift that many analysts believe would lead to a stronger renminbi.
However, the majority view was that the liberalisation would only apply to outward flows; a move that would actually weaken the renminbi.
