Business / Financial Markets

BOJ has ECB in a bind as euro soars versus yen

by Kevin Buckland

Bloomberg

Mario Draghi had something new to worry about as he prepared for Thursday’s European Central Bank policy meeting: the euro-yen exchange rate.

The yen approached a six-year low versus the shared European currency after Bank of Japan Gov. Haruhiko Kuroda surprised investors late last week by extending his record stimulus program.

Kuroda’s actions jeopardize the weaker euro that analysts say Draghi needs to reflate the economy, heaping pressure on him to come up with a policy response.

“Kuroda has thrown down the gauntlet to Draghi,” Robert Rennie, the head of currency and commodity strategy at Westpac Banking Corp., said Tuesday in Sydney. “Whether Draghi will, or can, accept the challenge remains to be seen.”

Unless Draghi emulates the large-scale government-bond purchases, or quantitative easing, of his BOJ counterparts, money borrowed cheaply in Japan could increasingly flow into European assets, propping up the 18-nation currency, Rennie said.

An ECB spokesman in Frankfurt declined to comment on strategists’ views that the BOJ’s actions pile pressure on the euro region’s central bank to expand stimulus.

Most analysts expected policy makers to refrain from changes at Thursday’s meeting, while they remained split over the odds of sovereign asset purchases. Some saw a higher likelihood of additional easing at the December gathering.

The BOJ got out ahead of many of its peers by announcing on Oct. 31 that it raised the annual target for enlarging its monetary base to ¥80 trillion, up from ¥60 trillion to ¥70 trillion previously.

The move has pushed the yen down almost 4 percent versus the euro in just four days, a bigger drop than in any full month this year. The yen fell to 143.45 per euro Wednesday, about 1.5 percent from the December low that was the weakest level since October 2008.

There is a 75 percent chance of the euro-yen rate breaching that low by the end of March, up from 24 percent before last week’s announcement, options data show.

“The price that Mario Draghi should be most worried about this week is euro-yen,” Jim McCormick, the global head of asset allocation at Barclays PLC in London, said Tuesday. “The ECB will step up, but things aren’t bad enough for them to do that yet.”

Quantitative easing, or QE, is the key measure for the Europeans to adopt, according to McCormick. James Kwok, the London-based currency chief at Amundi Asset Management, which oversees about $1 trillion, said “much more” euro depreciation is needed to stave off deflation. That will be difficult unless the ECB adopts a QE program, he said by email Monday.

When the Governing Council of the ECB met in Frankfurt on Thursday, it was expected to seek to boost an annual inflation rate which, at 0.4 percent in October, is languishing below the target of just under 2 percent.

Such slow inflation underscores how weak growth is and raises concern that deflation could set in, which would discourage consumption further and deepen the economic slump. A weaker currency can help ease that problem by pushing up the cost of imports and also would boost the economy by supporting exporters.

Citigroup Inc., the world’s biggest currency trader, predicts that policymakers will refrain from additional easing measures this week even as the euro’s gains versus the yen threaten to make European exports less competitive.

“The BOJ’s action last week has increased pressure on the ECB to act,” said Valentin Marinov, Citigroup’s head of European Group of 10 currency strategy in London. “The overlap between German and Japanese exporters in particular, and the advantage that the latter have gained on the back of recent yen weakness, did not go unnoticed.”

Societe Generale SA estimated in October that a 10 percent slide in the euro would boost Airbus Group NV’s earnings by 30 percent, LVMH Moet Hennessy Louis Vuitton SA’s by 29 percent and Unilever NV’s by 10 percent.

Median estimates of more than 40 analysts surveyed by Bloomberg put the euro about 4 percent lower at $1.20 by the end of next year, with the yen down 0.5 percent at 115 per dollar. The euro already reached a more than two-year low this week against the dollar after months of ECB easing measures and interest-rate cuts, while the yen fell to the weakest level since 2007.

“What you’ve got is a race to the bottom,” said Nicholas Gartside, the chief investment officer for fixed-income at JPMorgan Asset Management Inc., which oversees $1.5 trillion. “Sometimes it will be the yen, sometimes it will be the euro.”

Still, the yen is falling faster when measured among a basket of 10 developed-nation currencies. Japan’s currency weakened more than 5 percent in the past three months, the biggest drop in the group, while the euro slipped 0.6 percent.

For Standard Chartered PLC, both the ECB and BOJ are engaged in “currency wars,” a term popularized by Brazil Finance Minister Guido Mantega in 2010 to describe competitive devaluation to boost growth.

While the two central banks have acknowledged the economic benefits of a weaker currency, both Draghi and Kuroda have stressed that their policies do not specifically target their exchange rates. Japan’s policy chief upped the pressure on his European counterpart Wednesday by saying the BOJ will do whatever it can to achieve its 2 percent inflation target as soon as possible.

“Currency wars have again moved center stage, with the euro area and Japan adding excess liquidity and openly discussing the merits of currency weakness,” Callum Henderson, the Singapore-based global head of foreign-exchange research at Standard Chartered PLC, said Tuesday. “There’s no question that the path to unorthodox monetary policy has been much smoother for the BOJ than the ECB.”