Standing Fast

by Claus Vistesen

Hardly any economist or analyst battered an eyelid when the BOJ chose yesterday to hold the main interest rate at 0.5%. Indeed much of the recent data coming out Japan (and here) recently point to considerable risk of Japan slipping into deflation in 2007 and on that note most economists (including yours truly) expect the BOJ to be in a holding mode for the time being especially as the US economy is to slow down further into 2007.

(from Bloomberg)

Japan's central bank kept interest rates unchanged as consumer prices threaten to drop, making it hard to justify a second consecutive increase.

Governor Toshihiko Fukui and his policy board voted unanimously to keep the key overnight lending rate at 0.5 percent, the lowest among major economies, the Bank of Japan said in a statement today in Tokyo. The bank doubled the rate last month.

``The Bank of Japan probably wants to monitor the effect of the February rate hike,'' said Mamoru Yamazaki, chief Japan economist at RBS Securities Japan Ltd. in Tokyo.

Political pressure ahead of an election in July will also make it difficult for the bank to tighten credit until the last quarter of 2007, Yamazaki said. Business confidence in Japan probably fell from the highest in two years amid concern the U.S. economy may slow, the bank's Tankan survey may show next month.

The yen traded at 117.92 per dollar at 5:44 p.m. in Tokyo compared with 117.87 before the announcement. The yield on Japan's 10-year bond fell 1.5 basis points to 1.56 percent.

Today's decision was predicted by all 49 economists surveyed by Bloomberg News. Fukui said after last month's meeting that the board has no plans to raise rates consecutively.

The governor later told reporters that the U.S. economy remains likely to expand gradually, even after weak data raised concern that growth in Japan's largest export market may slow.

(...)

Reports may show Japan's core consumer prices dropped in February or March because of cheaper oil, Fukui said. Core prices, which exclude fresh food and are a key gauge of inflation in Japan, failed to rise in January after climbing 0.1 percent year- on-year in December.

Fukui said the drop in core prices wouldn't necessarily be bad because lower oil costs help economic growth. Core prices will stay on an expansionary path in the long term, he added.

Kazumasa Iwata, one of the bank's two deputy governors, said at the meeting that the policy makers should explain their outlook for consumer prices more clearly, according to Fukui. Iwata was the sole dissenter to last month's rate increase.

As always, Morgan Stanley's Japan watchers are also following the situation closely and the recent comment from Takehiro Sato as a preview of the Tankan business confindence survey which then failed to come through according to Mr. Sato's expectations of an increase relative to December. In fact, the survey showed that business confidence dropped albeit ever so slightly from the December figures.

Please Take Note

by Claus Vistesen

My regular postings and data watching from the Eurozone and Japan have been somewhat absent as of late. However, I am going to take it up again now and I will begin with Japan. There are many aspects here and one of them is of course the recent rate hike in the overnight lending rate from 0.25% to 0.50% where Edward so eloquently reminded us to look to the past in order to adequately analyze the situation and crucially Edward also voiced his criticism towards those who are so fast and sure in their of the sustainable Japanese recovery. Now, let me put this into some kind of time frame, the recent hike came at the end of February and on the back of positive 4th quarter GDP figures as well as of course the worry about carry trade and the subsequent international pressure on the BOJ. So was the BOJ rate hike in February a sound move based on economic fundamentals? Let us begin with with the Japanese industrial production which slipped 1.5% in January as well as Japanese retail sales which continued their secular decline posting a 0.8% decline as well in January. Adding to all this, Japanese inflation turned to zero in January.

(from Bloomberg - bold parts are my emphasis)

Japan had zero inflation in January, underscoring the nation's struggle to overcome seven years of slumping prices.

Core consumer prices, which exclude fresh food, were unchanged from a year earlier, the statistics bureau said today in Tokyo, matching the median estimate of 39 economists. It's the first time prices failed to rise since May, and followed a 0.1 percent gain in December.

Wages fell the most in more than two years, a separate report showed, damping prospects for faster inflation and higher interest rates in the world's second-largest economy. The Bank of Japan raised rates for the second time in six years last week and Governor Toshihiko Fukui said further increases will be gradual.

``The Bank of Japan isn't going to be able to raise rates as long as CPI is negative,'' said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management in Tokyo, who expects prices to drop next month. ``We're not going to see inflation pick up unless we see wages start to rise.''

So please take note ...

Take note that all the data cited above are from before the BOJ hike in February which of course does not at all bode well for Japan's so-called sustainable recovery and retreat from deflation. Methinks that Takehiro Sato from MS is probably and sadly going to be right on cue on his deflation call for February-March. Also take note that the paradox (excellently described by Dave Altig) in terms of how the recent hike actually caused a depreciation of the Yen may now revert to the opposite as investors seem to have become struck by a recent bug of risk aversion as markets have become rather volatile in the recent days. This has subsequently caused a flight to safe havens by investors and the Yen, sadly for Japan in this case, represents such a safe haven.

(from the FT - hat tip EuroIntelligence)

The Japanese currency has strengthened as recent volatility in global markets prompted a flight to quality that has put pressure on carry trades, in which long positions in high-yielding assets are funded by selling low-yielding currencies such as the yen.

So take note, an appreciating Yen is perhaps at this point driven by short term volatility and as markets stabilize (if and when of course they do) the carry trade might resume its merry way. However, as we keep the January inflation figures fresh in mind as well as the dampening effect of the February hike itself might begin to materialize, the deflationary push related to an appreciating currency is, quite frankly, not what Japan needs in these months with the CPI index seriously flirting with negative territory.

Finally, please take note that although I worry/think about excess liquidity and subsequent excess risk taking as much as the next man pressuring the BOJ to raise rates is not a conceivable way forward from this point. We need to understand why real global interest rates are as low as they and why liquidity and inflation do not seem parallel results of this low interest rate environment. Not until we get to grips with this apparent conundrum can we begin to apply the right tools to adjust the valves of the global econom.

Update on Saturday, March 3, 2007 at 11:15PM by CV

More info on the apparent 'unwind' of the carry trade. I am sure this is only going to temporary in the sense that the fundamentals won't change. However, I do feel that this short term appreciation of the Yen is not welcome in Japan as it is associated with deflation.

(from Bloomberg - linked above)

The yen strengthened the most against the dollar in almost 15 months this week as falling stock markets prompted investors to unwind trades they had financed by borrowing the Japanese currency.

Investors exited the so-called carry trade as they cut their appetite for riskier assets in emerging markets and moved into U.S. government debt. Investors have taken advantage of the lowest interest rate among major economies in Japan to borrow yen and buy higher-yielding assets elsewhere.

``Traders continued to liquidate their carry trade positions,'' said John McCarthy, director of currency trading at ING Financial Markets LLC in New York. ``The yen is the market leader now, and other currencies are under pressure.''

Japan's currency gained 3.7 percent this week, the biggest increase since the period ended Dec. 16, 2005, to 116.80 per dollar yesterday, from 121.08 on Feb. 23. It reached 116.43 yesterday, the highest since Dec. 11. The yen rose 3.5 percent to 154.10 per euro from 159.38 at the end of last week. The 13- nation currency has fallen from a record 159.65 yen on Feb. 23.

(...)

``The move we've seen has nothing to do with the economic fundamentals,'' said Lara Rhame, a senior currency strategist at Credit Suisse Group in New York. ``It's the animal spirit of the market. We will probably see more unwinding of yen carry trade in the short term.''

Swiss Franc

Hiroshi Watanabe, Japan's top currency official, said on March 1 that he sees only ``limited'' effects from the unwinding of carry trades.

The Swiss franc, another currency that is used to fund carry trades, posted a fifth weekly gain versus the dollar. It traded at 1.2165 against the U.S. currency yesterday, from 1.2326 a week ago.

Lehman Brothers Holdings Inc. is recommending clients buy the Swiss currency versus the U.S. and Australian dollars. Lehman, the fourth-largest securities firm, is also telling investors to remain short in the South African rand. A short position is a bet against a currency.

Yen gains may be limited on speculation the carry trade will recover as investors regain confidence in riskier assets.

``There are really few reasons to extend the yen rally,'' said David Watt, senior currency strategist at RBC Capital Markets Inc. in Toronto, a unit of Canada's biggest bank by assets. ``The economic backdrop of the carry trade hasn't changed. Japan still has low interest rates.''