ESM bond purchase is no back door yen intervention

By:
Peter Garnham
Published on:

The sell-off in the JPY has been dramatic in recent weeks but the announcement that Tokyo intends to buy European Stability Mechanism (ESM) bonds should not be seen as soft intervention by the Japanese authorities.

The JPY has not closed stronger for two consecutive days for a month, demonstrating the continuous selling pressure the currency has been under since the view took hold that the new government in Tokyo is to attempt to weaken its currency and turn it into a monetary policy tool to kick-start the economy.

USDJPY has risen by about 10%, while EURJPY has climbed 13% during the past two months, with little interruption to the JPY weakening trend. Moves such as that always leave FX markets ripe for a correction, and it is little wonder the move looks now to be running out of steam.

Furthermore, there is likely to be disappointment for those hoping further JPY weakness will be triggered by Tuesday’s announcement from Taro Aso, Japan’s finance minister, that Tokyo intends to buy ESM bonds and will continue to purchase euro-denominated debt.

Indeed, rather than anything new, it is a natural development, with the ESM set to replace the European Financial Stability Facility (EFSF).

Japan bought around €7 billion of EFSF bonds to the end of 2012, accounting for 6.7% of total issuance.

“As such, it is an exaggeration to describe the announcement as a new measure intended to materially weaken the yen – rather it is a continuation of FX reserves policy,” says Lee Hardman, currency analyst at Bank of Tokyo-Mitsubishi UFJ.

Of course, at the margin the decision does offer support to the view that the EUR might receive greater support from reserve diversification flows this year, especially if the weaker JPY tone remains in place.

Still some remain sceptical of Tokyo’s ability to influence sentiment.

As Julian Jessop, chief global economist at Capital Economics, points out, Japan’s EFSF bond purchases during the past two years has not prevented the eurozone crisis from escalating and the JPY from strengthening.

“Looking ahead, whether the eurozone crisis eases further or flares up again, and hence how the yen responds, will continue to depend overwhelmingly on developments in Europe itself,” he says.

“Japan might still want to show some solidarity with its European partners, and to benefit from the higher yields available on ESM bonds. But its purchases are essentially a sideshow.”