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Yen's Brexit surge seen testing 95 in threat to BOJ stimulus goals

Monday, June 27, 2016 - 13:17
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The yen was closing in on 99 per US dollar at one point Friday and headed for its biggest gain since it was freely floated in February 1973, as Britain's vote to leave the European Union prompted investors to flee global markets and seek safety in Japanese government bonds.

[TOKYO] When Mohamed El-Erian called the yen at 106 per US dollar "a total nightmare" for Japan this month, few envisaged it would get even worse so quickly.

The yen was closing in on 99 per US dollar at one point Friday and headed for its biggest gain since it was freely floated in February 1973, as Britain's vote to leave the European Union prompted investors to flee global markets and seek safety in Japanese government bonds.

The currency was at 101.89 as of 1pm in Tokyo on Monday. Some strategists and investors say the rally isn't over, with HSBC Holdings Plc, Citigroup Inc, and hedge fund GCI Asset Management Corp mooting a rise to 95.

The currency came within six yen of erasing the impact of more than three years of central-bank stimulus, piling pressure on policy makers to slow the advance.

Investors are braced for them to fail, with a gauge of demand for protection against appreciation over the coming month climbing to a six-year high Friday. At its peak, the yen was almost 7 per cent stronger than when Mr El-Erian, chief economic adviser at Allianz SE, voiced his concern.

"The UK's surprise decision to leave the EU is like a Black Swan event," said Tadashi Matsukawa, the Tokyo-based head of fixed-income investment at PineBridge Investments Japan.

"Brexit will make the market even more focused on an expansion of BOJ easing."

'Too Strong'

The yen rally will reduce Japan's import costs and render its exports less competitive, making the central bank's 2 per cent inflation target a more distant prospect. Mr El-Erian said on Bloomberg Television on June 3 that the yen was "a nightmare for the Bank of Japan" and "too strong for that economy."

Foreign-exchange strategists surprised by the yen's strength have raced to keep up with the market. The median year-end forecasts compiled by Bloomberg at the start of the year foresaw a 3.6 per cent slump in the exchange rate, which was around 120 back then. Now they foresee an 8.7 per cent drop to 112.

HSBC strategists led by David Bloom changed their year-end US dollar-yen target to 95 from 115 Friday, while Steven Englander, the New York-based global head of Group-of-10 currency strategy at Citigroup, the world's biggest currency trader, says it could reach that level in the "next month or two".

GCI Asset Management's chief foreign-exchange strategist, Tatsuhiro Iwashige, said he wouldn't be surprised if it touched 95 within weeks.

Those levels may be painful for Japanese companies. The country's large manufacturers said in a BOJ quarterly survey in March that they were assuming an average rate of 117.46 per US dollar in their fiscal 2016.

Monitoring Actions

Japanese Prime Minister Shinzo Abe said Monday he told finance minister Taro Aso to work with the BOJ to monitor financial markets closely, as officials held a meeting in Tokyo. Mr Aso said Mr Abe asked for various measures to stabilize markets.

On Friday, Mr Aso and BOJ governor Haruhiko Kuroda released a joint statement pledging to work together closely, and asserting that stability in financial markets is "crucially important."

The government and central bank are considering measures including unilateral intervention to counter abrupt gains in the yen, the Nikkei newspaper reported Saturday, citing an unnamed finance ministry official as saying action is possible even without US approval in a "fight" to protect ''national interests".

Lines in the Sand?

Market watchers including Eisuke Sakakibara, who earned the moniker Mr Yen for his ability to influence the exchange rate as a Japanese finance ministry official in the 1990s, see the risk of intervention expanding if the exchange rate accelerates beyond 100 per US dollar. Strategists have speculated for months on where the line in the sand might be, identifying levels including 105 yen or 100 yen.

"It doesn't seem like they've got G-7 support for coordinated intervention, and I think they probably understand that independent intervention won't work terribly well," Alan Ruskin, global co-head of foreign-exchange research at Deutsche Bank AG in New York, said on Bloomberg Television on Friday.

The benchmark gauge of progress toward the BOJ's 2 per cent inflation goal has fallen for two straight months, after a year of stagnation. The economy has contracted in four of the past eight quarters.

"We could see the UK vote having an effect on the Japanese economy through falling stock prices lowering asset values or a strengthening yen damping corporate sentiment," said Kazuhiko Ogata, chief Japan economist at Credit Agricole SA.

"Brexit has boosted the probability of additional stimulus."

BLOOMBERG