From a medium-term perspective, there will be a further erosion of confidence in the Japanese fundamentals as the debt burden continues to increase and the government is forced to maintain a highly-expansionary fiscal policy. The Bank of Japan will also maintain a very aggressive monetary policy to help support the economy. The yen will lose support when risk appetite improves, especially as the currency will be seen as a more attractive funding currency if there is increased speculation over a Fed tightening. There will still be some reservations over selling the yen aggressively with high volatility still an important feature.
The dollar found support above 81.50 against the yen early in the week and managed to break a series of resistance levels with a peak near 83.70 in Asia on Tuesday.
The yen remained vulnerable against the dollar on yield grounds, especially with further speculation that the Fed will shift towards a tighter monetary policy. There was also further interest in carry trades funded through the yen as markets looked to take a positive attitude towards risk.
The Japanese Tankan report was broadly in line with market expectations with a rise to 6 in the first quarter from 5 previously. The impact was limited, especially as a high proportion of the responses were received before the March 11 earthquake. There was some disappointment that capital spending plans were scaled back and underlying confidence in the Japanese fundamentals remains weak.
Capital repatriation flows also slowed which lessened support for the yen. Industrial production rose 0.4% for February, but the impact was minimal given that production will dip sharply in the near term. There were suggestions that an initial extra budget could be in the region of JP2trn and the fiscal position remains perilous.
Sterling:
Growth and inflation trends will continue to be watched very closely in the near term. There will be strong pressure on the Bank of England to raise interest rates on inflation grounds, especially as the headline rate could move above 5.0%. There will be a lack of confidence in the growth outlook, especially with consumer spending already vulnerable, and real interest rates will remain highly-negative for Sterling which will have a negative impact. There is also the risk of fresh doubts surrounding the banking sector which could have a serious negative impact on the UK currency.
Sterling remained under pressure early in the week and dipped to two-month lows around 1.5935 against the US dollar while the trade-weighted index declined to a 2011 low. The Irish and European banking sector will be watched closely as renewed stresses would also tend to unsettle the UK currency.
Fourth-quarter GDP data was revised to -0.5% from -0.6% previously while there was also some improvement in bank lending and mortgage approvals. The current account deficit for the fourth quarter widened to GBP10.5bn from GBP8.7bn previously as the goods deficit widened to an all-time high. The data overall continued to suggest a very fragile economy, but also indicated the possibility that credit conditions were easier.
Business confidence dipped and there were increased fears that the tight government fiscal policy would have a greater than expected impact in weakening the economy with spending hit by falling real incomes. There were also expectations that weak growth would deter the Bank of England from more than a marginal monetary tightening which would leave interest rates highly negative in real terms.
There was a stronger than expected CBI retail sales report for March. In comments on Tuesday, MPC member Weale maintained his call for an early increase in rates to stem inflation which provided some Sterling support. |