Currencies

Yen Slides

paul@bluesearchltd.co.uk
The yen came under pressure on Tuesday as the Bank of Japan started its policy-setting meeting with the market split as to whether the central bank would raise interest rates. 

The decision, due on Wednesday, has focused market attention given its potential to disrupt carry trades, in which long positions in high-yielding currencies are funded by selling low-yielding currencies such as the yen.

The popularity of carry trades has helped send the yen to a series of multi-year lows in recent months. However, not only were analysts divided on the possibility that the BoJ would raise rates by 25 basis points to 0.5 per cent, but there was doubt as to whether it would affect investor appetite to use the yen as a funding currency in carry trades.

Ian Gunner, currencies strategist at Mellon Financial, said that if the BoJ raised rates, the yen was likely to strengthen initially, although any rally might prove short-lived.

“It seems unlikely, given the uncertainties in the [Japanese] economic data, that the market will suddenly move to adopt a strong future rate hike profile and this is what is needed to really snuff out the basic arguments behind the carry trade,” he said.

David Woo, at Barclays Capital, concurred. He said a 25 basis-point rate rise would have a limited impact on structural capital outflows by Japanese investors and therefore he expected yen depreciation to resume after the BoJ meeting.

“Also, the market is likely to assume that the hurdle to subsequent rate hikes ahead of the July Upper House election will be very high,” Mr Woo added. “Our view is the BoJ will not raise rates again until September.”

By mid-afternoon in New York, the yen dropped 0.5 per cent to Y120.10 against the dollar, fell 0.4 per cent to Y157.90 against the euro and lost 0.6 per cent to Y234.90 against sterling.

Meanwhile, the low-yielding Swiss franc also lost ground, dropping 0.3 per cent to SFr1.2360 against the dollar and 0.2 per cent to SFr1.6250 against the euro.

Henrik Gullberg, strategist at Calyon, said while some observers had put the advance of the Swiss franc against the dollar down to the strength of the economy and hawkish comments from Swiss National Bank officials, the move more probably reflected a more general caution over carry trades ahead of the BoJ interest rate decision.

According to Mr Gullberg, while SNB officials might be sounding increasingly hawkish, it was unlikely that investors were pricing in a significant probability of a step-up in the pace of Swiss interest rate tightening after weak inflation figures.

“The bottom line is that a more aggressive tightening campaign in Switzerland is unlikely as long as inflationary pressures remain subdued,” said Mr Gullberg. “This would in turn suggest that, near-term, the Swiss franc is likely to resume its weaker trend once the BoJ meeting is over.”

Elsewhere, the dollar dropped to a seven-week low of $1.3189 against the euro in early trade on reports that US plans for air strikes on Iran extended beyond nuclear sites to include its military infrastructure.

Ashraf Laidi, chief foreign exchange analyst at CMC Markets, said US military action in Iran would be dollar negative as it not only raised the risk of retaliatory attacks on US interests in and outside the US, but also endangered oil supplies in the Hormuz strait through which more than 25 per cent of the world’s oil flows.

The dollar reversed it losses later however, to stand flat at $1.3150 against the euro. Sterling advanced after figures revealed UK mortgage lending rose strongly and building society mortgage approvals hit record levels in January. The pound rose 0.2 per cent to $1.9560 against the dollar and climbed 0.3 per cent to £0.6720 against the euro.

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