Yen weakness: it’s the current account, stupid

By:
Peter Garnham
Published on:

Much has been made of the effect of Tokyo’s desire to use its currency as a policy tool to promote growth as a driver of recent yen weakness, but some believe there are greater forces at work.

The yen has strengthened by more than 1% against the dollar since the Bank of Japan (BoJ) meeting on Tuesday, at which it moved to a 2% inflation target but delayed open-ended asset purchases until 2014.

That disappointed a market that was long USDJPY and was hoping for more aggressive near-term easing.

As Bank of Tokyo-Mitsubishi UFJ points out, the BoJ’s reluctance to further increase planned asset purchases in 2013 indicates that Masaaki Shirakawa, the central bank’s governor, is not fully signed up to achieving the new 2% target at the earliest possibility.

Masaaki Shirakawa, governor of the Bank of Japan.
 In other words, it amounts to more of the same from the BoJ, immediately undermining the credibility of the new 2% target.

Of course, many will point to the fact that Shirakawa is set to be replaced in April, and that his replacement is more likely to toe the Japanese government’s ultra-dovish line. In that case, any rally in the yen should present an opportunity for investors to re-enter short positions.

Some, however, believe that monetary policy is not the main driving force behind yen weakness, and that waiting for Shirakawa’s replacement before selling the currency could result in a lost opportunity.

Richard Grace, chief currency strategist and head of international economics at Commonwealth Bank, believes the yen is weakening because Japan now has a structurally smaller current account surplus, not because of the BoJ’s quantitative easing (QE) policy – a regime that has been in place for more than 10 years on and off.

He notes that since the BoJ restarted its QE programme in October 2010, the central bank has only completed 66% of its targeted asset purchases.

“Hence a delay to more aggressive quantitative easing until January 2014, as announced yesterday, should be assessed against the fact that the BoJ are not even fulfilling the current milder asset programme,” says Grace.

 
Source: CBA

 

The fact that modest asset purchases have combined with the yen falling by nearly 14% against the dollar since mid-November gives Grace confidence that the yen is weakening because of Japan’s smaller current account surplus rather than the BoJ’s QE programme.

Indeed, the sharp rally in USDJPY occurred just after Japan registered its first monthly current account deficit in three decades.

 

 
Source: CBA

 

That narrowing in Japan’s current account surplus is occurring because its long-run trade surplus has moved into deficit as energy imports have risen in the wake of the tsunami that caused devastation in the country in 2011 and as exports have underperformed. In addition, Japan’s household savings rates are declining.

“The drivers behind Japan’s smaller current account surplus have not changed and so we anticipate USD/JPY will continue its march higher after it has undergone its period of consolidation,” says Grace.

“Market disappointment at yesterday’s BoJ announcement provides the perfect catalyst for a period of USDJPY consolidation, and to establish some additional long USDJPY positions.”

Commonwealth Bank predicts that the structurally smaller Japanese current account surplus will drive USDJPY up to ¥100 by the end of the year. That should go down well in Tokyo.