Bank Of Japan To Intervene To Halt Overvalued Yen?

Sometimes currencies become under or overvalued and, although this can last for a significant time, it is usually fuelled by heavy speculative or investor safe haven flows to a given currency. Recent strength of the yen reflects strong safe haven demand fuelled by the EU debt crisis. The yen rose 8.3% versus the euro and 6.6% versus the dollar in May. On Tuesday, a senior official with the International Monetary Fund (IMF) said that the yen is moderately overvalued, that intervention is an option to ease forex volatility and called for more aggressive monetary policy easing from the Bank of Japan (BOJ).
 
The IMF statement that the yen is moderately overvalued reflects negative short-term fundamentals in Japan. These negative fundamentals include slowing exports and widening of the trade deficit, weakening of the current account surplus, rapidly rising public debt, slow fiscal reform and low interest rates. Investors, however, continue to favour the yen as a safe haven destination, primarily because the country is the world's largest creditor nation and has run a chronic current account surplus since the 1980’s.
 
Japan posted a larger than expected trade deficit in April reflecting reduced demand from China, slowing global demand and impact of the strong yen on Japan's export competitiveness. In January, Japan reported its first current account deficit in over three years. Japan's public debt, the highest among industrialised nations, continues to rise and gross debt ratio may soon pass 200% of GDP. The main reason that Japan's public debt situation has not hurt the yen is that Japanese investors hold about 95% of Japan's government bonds. This adds stability to the bond market. If Japan is forced to raise money abroad, the yen may weaken.
 
Concern about Japan's rising public debt encouraged credit rating agency Fitch to cut Japan's credit rating last month and the IMF says that Japan needs to do more and demonstrate greater commitment to fiscal reform.
 
BOJ interest rates have been at record lows for a number of years. The central bank has implemented significant quantitative easing measures to help the economy recover from the record earthquake in March of 2011, combat deflationary pressures and try to weaken the yen. The central bank is under intense domestic political pressure to ease again to weaken the yen and the IMF sees the need for more aggressive monetary policy easing and forex intervention.
 
Last November, Japan followed record unilateral forex intervention with a series of small interventions. Historically, unilateral or solo invention has limited long-term lasting impact. These interventions were sparked by fear that the strong yen would hurt exports and the recovery from the earthquake. Many of the G7 governments were critical of Japan's yen selling intervention which makes coordinated intervention unlikely. The IMF statement that intervention is an option to reduce forex volatility may embolden Japan to intervene again and reduce criticism from other industrialised nations. At the start of June, Japanese authorities contacted trading desks at several banks to check rates, which is often a prelude to intervention.
 
Fundamentals for the yen have been weak for some time, but the currency remains strong. If the trend towards widening of the trade deficit, weakening of the current account surplus and deterioration of public finances continues it could soon lead to depreciation of the currency and make intervention a much more potent tool.
 
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