Reacting to the devastating impact of the earthquake that struck on Friday, the Japanese central bank has announced its intention to pump a record ¥15tn into the economy ($183bn). This follows the reaction of the Reserve Bank of New Zealand to the earthquake that struck Christchurch, which opted to cut rates by 0.50%. With Japanese interest rates currently at next to nothing (<0.10%), the Bank of Japan clearly can’t follow suit, and has therefore opted to loosen monetary policy through flooding the money markets and buying government bonds.
The two countries’ approaches are alternative ways of achieving the same basic goals - to give consumers ‘a break’ in amid social upheaval and to provide support to fragile economic growth.
The so-called policy of quantitative easing that Japan has announced this morning invariably has the effect of weakening the economy’s national currency. The US Federal Reserve’s ‘QE II’ program has been responsible for the dollar’s woeful underperformance over the past year or so. Money-printing increases supply, thus weakening the currency as demand eases.
Accordingly, the yen declined against 13 of its 16 major counterparts as markets reacted to the news. However, just as the New Zealand Dollar did in the immediate aftermath of its rate cut last week, the yen has rebounded relatively strongly. There is a sense that New Zealand’s economy may eventually benefit from Christchurch’s disaster, with its construction sector in particular expected to enjoy strong growth. The same was thought of the Japanese construction sector but the apparent devastation suffered in the country’s north-eastern region seems set to provide a genuine setback to the Japanese economy in 2011. The country has suffered major damage to its infrastructure- most notably its roads and highways, factories and nuclear plants.
Fundamentally, we can be pretty confident of one thing- the yen will not strengthen this year. The Japanese government has this morning said as much. It threatened intervention to curb any sudden yen appreciation, asserting that it “will take decisive steps if necessary” (indeed the BOJ acted on their threat in September last year, though the impact was fleeting). So anyone hoping for a yen appreciation to mirror the aftermath of Japan’s last major earthquake in 1995 will be disappointed.
Behind the government statement is the concern that Japan is an export-dependent country which relies on weaker exchange rates particularly in times of low-growth. When a government makes this sort of statement, market appetite for the related currency is understandably dampened.
Will the yen decline? Well, the scale of the disaster is continually being revised up, and in light of this morning’s government statement, the yen could be set to weaken despite a thus far robust post-quake performance. In addition, we see risk appetite increasing over the course of 2011 and anticipate that funds held in yen will be redirected to higher-yielding, riskier currencies.
Richard Driver
Analyst – Caxton FX
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