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09/05/2011

Japanese Yen: Action Against Appreciation

Kyohei Morita, Yuichiro Nagai and James Barber, Barclays Capital, Tokyo.

This article appeared in the August 2011 issue of Current Economics with permission of the author.

Key Concepts: Currency Appreciation | Intervention |

Key Economies: Japan |

 

The Ministry of Finance (MoF) conducted a unilateral Japanese yen (JPY)-selling intervention on August 4. The size of the operation was undisclosed, but the US$/JPY rose from 77 immediately before the intervention to around 80 by early evening, suggesting its initial effects were substantial. This was the first such intervention by the MoF since March 18, when it sold JPY692.5bn in response to the post-earthquake surge in the yen.

Soon after the intervention, the Bank of Japan (BoJ) announced that it would end its monetary policy meeting a day early. By mid-afternoon, it had announced measures of its own, expanding the asset-purchasing fund to JPY15tn from JPY10tn with increases of 50% or more in the sums used to buy Japanese government bonds (JGB), treasury bills and exchange traded funds.

Equity and bond markets, however, were largely unchanged. Perhaps they had already anticipated the action, which was well-flagged through local media outlets, or maybe they were simply hoping for more. In any case, the Nikkei average only rose to 9659 from the previous day’s close of 9637, while 10-year JGB yields edged up to 1.017% from the previous day’s 1.012%, despite dropping to 0.995% at one point during the day.

More important than the initial market moves, of course, is whether they will last. In our estimates, a 3-yen shift in the direction of yen depreciation, assuming it is sustained, raises real GDP by 0.10% in Year 1, 0.16% in Year 2 and 0.08% in Year 3. If coupled with higher share prices and lower long-term yields, the effect is naturally larger. The estimates in Figure 1 assume that, in addition to a 3-yen move in the US$/JPY, the Nikkei rises by 500 yen and long-term yields fall by 10 basis points. These parameters, however, can be adjusted. The useful feature of this model is that the estimates have proportionality, allowing investors to easily conduct their own simulations as expectations change (e.g., as a 500 yen rise in the Nikkei exerts an impact of 0.04% on real GDP in Year 2, it can be assumed that a 1000 yen drop in the Nikkei exerts an impact of 0.08%).

At this stage, we find it difficult to expect a sustained reversal in the exchange rate trend. Indeed, the US$/JPY has already retraced much of its initial move. Given Japan’s external solvency and liquidity, evident in its current account surplus, the yen will likely continue to stand out as a safe haven for market participants in “risk off” environments.

Figure 1: Macroeconomic effects of a weaker yen, stronger share prices, lower yields

effects of a weaker yen, stronger share prices and lower yields


That does not necessarily mean the Japanese authorities are done taking action. With its economic outlook intact, however, the BoJ will likely refrain from more aggressive measures for now. Yet it is clearly more focused on downside risks than it was before, especially in relation to the overseas economy, and now says that there is a possibility that these developments “and the ensuing fluctuations in the foreign exchange and financial markets may have adverse effects on business sentiment, and consequently on economic activity in Japan.”

Further monetary easing by the Swiss National Bank (SNB) could also create potential pressure for BoJ action, not so much because it would provide a convenient excuse, but more because it could increase Japan’s relative appeal as a safe haven and push up on the yen. The fact that the August 4 move was preceded a day earlier by SNB easing was probably more than a coincidence.

Regardless of whether the BoJ “actively” takes additional measures, it has already “passively” set the stage for unsterilized intervention in the FX market. This relates to its “complementary deposit facility,” which pays interest on excess reserve balances. As the applicable rate (0.1%) has been at the upper bound of the target range for policy rates (0-0.1%) since October 5, 2010, the BoJ can allow increases in current account deposits due to JPY-selling intervention for a prolonged period without policy rates falling sharply below targeted levels. In short, there is little need to sterilize currency interventions (e.g., sell financing bills to absorb current account deposits).

But even if the BoJ has set the stage for leaving currency interventions unsterilized, there is still a need for the MoF to conduct further interventions in the first place. The effect of the intervention in early August, strong on Day 1, is already losing its sustainability. Our FX strategist argues that repeated action will be necessary and notes that the MoF has the fire power to conduct large-sized daily interventions for about a month (assuming JPY2trillion/trading day) and could increase the limit of intervention further by raising the annual limit of financing bills issuance when the third supplementary budget is compiled this fall.

In historical terms, the US$/JPY is still clearly in intervention territory (Figure 2). And even if this strength relative to the US$ matters less than it did in the past (Japanese companies have lowered their break-even exchange rate), the yen has also appreciated against a broad range of other currencies, including the Euro and Chinese renminbi. Indeed, it is at record levels on a trade-weighted basis. Such appreciation, a genuine concern for the Japanese economy, could also provide a justification for further intervention.

Figure 2: Where the US$/JPY sport rate was during past interventions

yen spot rate during past interventions



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