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Friday December 9, 2005 - 20:35:55 GMT
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FX Briefing 9 December 2005

FX Briefing 9 December 2005
• BoJ indicates possible end of zero rate policy, but dampens rate rise concern
• Production and order data confirms recovery in Germany
• Rating warning because of current account deficit hits NZD

Japan: economy top, currency flop

The dollar’s upward trend turned into a sideways movement at the beginning of this week . EURUSD traded between 1.17 and 1.18, USD-JPY at around 121. EUR-JPY temporarily reached an all-time high of 142.81. The kiwi dollar attracted unaccustomed attention mid-week. The New Zealand currency, together with the Aussie dollar, took a nose-dive after the rating agency S&P had warned that a widening of New Zealand’s current account deficit could jeopardize the country’s AA+ rating. However, in New Zealand itself, the weakening of the NZD was probably not altogether unwelcome: Reserve Bank governor Alan Bollard described the currency’s level as “unjustified“, but still raised the interest rate to 7.25%.

On Thursday, the US dollar also came under pressure for a time. EUR-USD improved to around 1.1850, and USD-JPY dropped to almost 120. Other low interest currencies such as the Swiss franc and the Swedish Krone also strengthened. Market participants put this down to profit taking. BoJ governor Toshihiko Fukui’s remarks that an end of the zero interest rate policy could be in sight, might also have played a role here. ECB representatives’ statements were also interpreted as hawkish, particularly in view of the positive economic data from Germany and two economic research institutes’ upward revision of their growth prognoses. Additionally, the FOMC meeting next Tuesday could possibly be casting the first cloud. On the one hand, a further fed funds rate hike (to 4.25%) is expected. On the other hand, many market participants are expecting the Fed to change its forward-looking language to a more open wording on further interest rate policy.

Japan: buoyant growth…
The Japanese economy has made a remarkable recovery. 2004 had already been a good year with real growth of 2.3%. However, this was largely due to a strong end of 2003/beginning of 2004; in the following quarters Q2 to Q4/2004 growth virtually came to a standstill. But then, in 2005, the economy soared again. According to the latest revised figures, the Japanese economy grew in the first two quarters by 5.0% and 5.7% respectively qoq. In Q3, growth weakened again slightly to 1.0% (also annualized), but private demand for consumer and capital goods was quite robust, especially in view of the strong previous quarters. The total result is dampened in particular by accelerated reduction of inventories. Also, the trade balance was neutral.

The short and medium-term perspectives are favourable too. Industrial production increased again in October. Machinery orders (excluding volatile components) have recovered from the September low, and companies seem to be showing considerable willingness to invest.

The Japanese trade balance has deteriorated significantly in the last few months. At the end of 2003/beginning of 2004, the monthly surplus was around JPY1100bn. At present, it is only in the region of JPY700bn. However, this is primarily due to the development of energy prices. A glance at the bilateral trade balances of Japan’s main export markets, shows growing surpluses vis-à-vis the US and the EU and almost stable surpluses in Asia on a high level. There is certainly no evidence of a loss of competitiveness. The exchange rate development will probably also have a positive impact. In trade-weighted and real terms, the yen is at its lowest level since 1985. This should spur on exports and companies’ returns substantially.

… but yield disadvantage burdens currency
The yen’s depreciation stands in stark contrast to the upswing in the Japanese economy, which is reflected in the equity market recovery and a tentative upward trend in the real estate market. The only conceivable, but powerful, reason for this is the interest rate divergence. Currently, investors get 440 basis points less on 3-month money in Japan than they get in the US, which makes the dollar look more than attractive. And those who are betting on a stronger yen are losing money every day.

For some time the Bank of Japan has been pointing out that the phase of deflation might be coming to an end. The BoJ now considers the upswing to be self-supporting and expects to see positive inflation rates soon (core rate, excluding fresh food); they might in fact already have been positive in November. Against this background, the BoJ has started to prepare the markets for a possible end of its quantitative easing policy some time in the next fiscal year, which begins in April 2006.

According to central bank governor Fukui, excess liquidity in the money market would be drained first of all, then interest rates would be kept stable at a very low level and only then would the central bank start to raise the interest rate level to bring it in line with economic conditions. So it will be a long time until America’s interest rate advantage over Japan is noticeably reduced.

On the other hand, USD-JPY’s upward movement from 109 at the beginning of September to over 120 has been long and practically uninterrupted. Moreover, the figures for securities transactions between Japan and the rest of the world have for some weeks been showing net inflows to Japan. In addition, next week’s Tankan will probably show notable improvements. And on the US side, there will be a change in the FOMC statement. Finally, the year is drawing to a close and liquidity is drying up somewhat. So maybe the time is ripe for some sort of consolidation.

Stephan Rieke +49 69 718-4114
Economics Department
+49 69 718-3642
[email protected]
Foreign Exchange Trading
[email protected]
Jörg Isselmann
+49 69 718-2695
Matthias Grabbe / Klaus Näfken
+49 69 718-2688

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHF-BANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities. This publication must not be distributed in the United States.
© 2005 BHF-BANK Aktiengesellschaft
All rights reserved. Please mention source when quoting from it.


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