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Yen Breaches Japan’s September 15th Intervention Level While Bank of Japan Lowers Interest Rate Target to 0.0%

October 6, 2010 (Bloomberg) -- The yen climbed versus the dollar for a second day, erasing all the loss incurred since the Bank of Japan moved to weaken its currency last month and spurring speculation that another intervention may follow.

The yen reached 82.77 per dollar today, the strongest since May 1995. It had previously reached a 15-year peak of 82.88 on Sept. 15, before the central bank intervened for the first time since 2004 to help the nation’s exporters.

The yen plunged more than 3 percent on the day of the intervention, weakening to 85.75 yen. Brazilian Finance Minister Guido Mantega said Sept. 27 that the world may be facing a “currency war.”

“It’s likely they will intervene if we continue to head lower, especially coming so soon after the steps that were undertaken by the Bank of Japan yesterday,” said Lee Hardman, a foreign- exchange strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. in London. The yen was up 0.4 percent to 82.91 per dollar as of 2:40 p.m. in London from 83.22 in New York yesterday.

‘Comprehensive Easing’

The Bank of Japan yesterday (October 5) lowered its benchmark interest rate to a range between zero and 0.1 percent. The central bank also said it would create a 5 trillion yen ($60 billion) fund to buy government bonds and other assets.

The move, called “comprehensive monetary easing” by Governor Masaaki Shirakawa, followed a slump in the outlook for growth in the BOJ’s quarterly Tankan survey last week.

Policy makers in the U.S. and the U.K. are considering similar steps to support their economies. At the same time, emerging markets from Brazil to South Korea are increasing currency controls as investment inflows threaten export growth.

“Yesterday’s measures from the BOJ are probably not enough to match the potential dollar supply that the market expects,” said Neil Jones, head of European hedge fund sales at Mizuho Corporate Bank Ltd. in London. “It’s a simple demand and supply equation. Dollar-yen should go down.”

Some investors had speculated Japan would refrain from intervening in the foreign-exchange markets before this week’s meeting of finance ministers and central bankers from the Group of Seven industrialized nations. Jim O’Neill, chairman of Goldman Sachs Asset Management, said he didn’t rule it out.

“The case for intervention to weaken the yen is actually quite strong,” O’Neill said in an interview with Deirdre Bolton and Erik Schatzker on Bloomberg Television. “I think if the yen were to strengthen above 82 for example, even if it were in the next couple of days, I think they probably would intervene.”

USD/JPY Recent Exchange Rate: September 15 to October 6, 2010

The chart below shows the USD/JPY exchange rate beginning with the September 15th, Bank of Japan intervention through trading on September 6th. As can be seen, after weakening on the day of intervention, the yen has strengthened, eventually breaching its pre-intervention level.

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Case Study: Exchange Rate Response to the Bank of Japan’s Lowering of its Target Interest Rate

The Bank of Japan’s lowering of its target interest rate can be viewed as an indirect intervention effort to weaken the yen. The lower interest rate could reduce the “asset choice” attractiveness of the yen. Of course, if the yen continues to be viewed as a safe haven currency, this lower interest rate is likely to have little effect. On the other hand, the lower interest rate in Japan, relative to other financial centers, might encourage additional carry trade strategies. These strategies would be expected to weaken the yen, assuming other factors constant. The rational for these a carry trade strategy involving the yen at this time is discussed as below.

Carry Trade Strategies:

The lower interest rate in Japan probably encourages more carry trade positions, and as one example, the AUD against the JPY. According to Bloomberg date, the following interest rate data can be observed between Japan and Australia for October 6, 2010

Australia:

Central Bank Interest Rate Target: 4.50%

3-month Government Treasury Bills: 4.39%

6-month Government Treasury Bills: 4.42%

1 year Government Treasury Bills: 4.66%

Japan:

Central Bank Interest Rate Target: 0.0% (effective, October 5)

3-month Government Treasury Bills: 0.12%

6-month Government Treasury Bills: 0.12%

1 year Government Treasury Bills: 0.11%

AUD/JPY Exchange Rate; October 5-6, 2010. Note: Chart corresponds to GMT and the announcement by the Bank of Japan regarding its lower interest rate target occurred just after 5:00am GMT (2:00pm in Tokyo) on Tuesday, October 5th.

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