Japanese Yen

The yen has been the world's strongest currency over the last 18 months, rising 40 per cent on a trade weighted basis. At a time of severe global economic slowdown this is putting Japanese exporters under intense pressure. The market value of the Japanese transport sector (a major exporter) is down more than 60 per cent, and total Japanese exports fell by an unprecedented 36 per cent in the year to last December.

The surge in the yen has come as the financial crisis has intensified, carry trades have been unwound, and investors have moved to favour currencies of countries with large external surpluses.

The yen was arguably undervalued from 2002 to 2007 as it became the major funding currency for carry trades. The recent move has, however, put it firmly into 'over-valued' territory.

Having been growing at an annual rate of 10 per cent as recently as the end of 2007, exports are down 36 per cent in the year to December 2008. The figures are likely to get worse as the domestic demand slowdown in Japan's major markets becomes more intense.

It has been clear for some time that the yen's movements are closely associated with perceptions of risk. When economic and market risks intensify, the yen rises, and when they ease, the yen falls back.

To the extent that the global economic environment continues to deteriorate and equity markets remain under downward pressure, this implies that the yen strength is likely to remain a feature of the market. Does this mean that the Japanese authorities are about to engage in significant intervention to halt the yen?

Between May 2002 and March 2004, the BoJ bought $350 billion against the yen in an attempt to prevent the yen from strengthening. This intervention met with some success in 2002/3 in that the dollar-yen remained above 115 for much of the period, but further dollar weakness in late 2003 and early 2004 saw dollar-yen fall as low as 103 despite a large increase in intervention.

Compared with the current position, the yen was not excessively strong, with a trade-weighted index some 20 per cent below current levels.

Given that the yen is significantly stronger now than it was in 2002-2004, and its appreciation over the past few months has been very sharp, the case for renewed intervention would appear to be strong. However, for a number of reasons, intervention does not look imminent unless we see very disruptive market conditions:

Japan is not suffering from deflation now so the immediate pressure from that source to prevent yen strength is not overwhelming. However, if Japan falls back into deflation which may happen in the second half of this year, and if the yen remains under upward pressure at that time, the risk of intervention will be much higher.

With the world economy weakening, protectionist pressures are likely to emerge as countries look to protect domestic employment. Aggressive intervention by Japan against the yen would not be well received by its trading partners in Asia and the West and could induce the threat of retaliation. Upward pressure may be easing - bond outflows have increased. The yen was under intensive upward pressure from last September to December as the equity markets fell sharply, but there are tentative signs that this pressure may be easing to some extent.

There can be little doubt that the recent surge in the yen is having a negative impact on an already weakening Japanese economy, and that Japan's policy options are very limited. Currency intervention would seem to be one route to pursue. However, intervention does not seem to be imminent.

This report was compiled by the Marketing Department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.