The economy will remain very weak in the short-term due to the continuing impact of earthquake damage and the Bank of Japan will maintain an extremely loose monetary policy to support demand. From a longer-term perspective, overall confidence in the government-debt situation will also remain weak as the government will have to contend with weaker tax revenue. There will be capital flows overseas, although it is also the case that there will be defensive inflows at times, especially when risk appetite deteriorates. Overall, the yen will find it difficult to sustain significant gains.
The dollar found support near 81.50 against the yen during the week, but it was unable to make strong headway as it was frustrated by wider weakness.
Underlying confidence in the Japanese economy remained weak after its credit rating was put on negative watch. The latest economic data continued to register the impact of earthquake damage as there was a very substantial 15.3% decline in industrial production while there was a sharp drop in household spending.
The Bank of Japan maintained a very loose economic policy with no policy changes at the latest policy meeting and there will be further interest in using the yen as a funding currency for carry trades. Underlying confidence in the economy was also undermined by a Standard & Poor’s announcement that Japan’s AA- rating was being put on negative watch.
Japanese institutions will remain an important influence and the evidence suggests that there will be further investment overseas, especially with the funds generally pessimistic over the yen.
Sterling:
Confidence in the growth outlook will remain weak in the short-term with fears of further downward pressure on consumer spending due to the impact of fiscal tightening. There will also be expectations that the Bank of England will resist pressure for higher interest rates which will severely curtail yield support. There will be important protection from a lack of confidence in the Euro-zone economy and dollar while the UK currency will tend to out-perform when international risk appetite is firm. It will still be difficult to justify any significant advance for Sterling given underlying vulnerabilities.
Sterling weakened in early European trading on Wednesday ahead of the GDP data release with media reports reinforcing market fears that there would be a weaker than expected reading.
In the event, there was a 0.5% GDP increase for the first quarter which was exactly in line with expectations. There was a strong rebound in services activity following the weather-related decline previously, but there was a decline in construction activity which dampened underlying demand.
There was a relief rally in Sterling following the release, but underlying unease over the economy will tend to continue, especially as there was no reported growth in the past six months. The data is unlikely to trigger a significant adjustment in Bank of England interest rate expectations with no increase expected at the May meeting which will limit Sterling support.
The latest CBI industrial orders data was weaker than expected, but there was general optimism surrounding the manufacturing outlook. There was a further deterioration in consumer confidence according to the latest GfK survey.
Bank of England MPC member Sentance maintained his hawkish tone towards interest rates in comments on Tuesday with further calls for higher interest rates. It is, however, significant that he will leave the MPC following the May meeting.
Dollar weakness was still the dominant market influence and Sterling strengthened to a high near 1.6750 against the US currency in Asian trading on Thursday. |