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The G-7 will probably soon be able to claim another currency victory, but not just yet.
Since Friday’s coordinated intervention, only the group’s sixth in 30 years, the yen has stabilized, with the dollar trading well over ¥80.
The sheer increase in yen liquidity, an improvement in global risk appetite over the weekend, and a renewed focus on inflation pressures around the world are all helping to reduce the risk premium in the Japanese currency for now.
But, given market uncertainty over just how far the G-7 is prepared to go, investors will likely still test its resolve and start pushing the yen higher again.
The dollar’s sharp rally, from a low of ¥76.25 before the intervention exercise was launched, reflected at least in part, fear over the power of G-7 coordination.
As UBS pointed out, the group has succeeded in four of its previous five intervention exercises. Its only failure was in 1987 when interest rate policy failed to support efforts to drive the dollar higher against the Deutsche mark.
This time, a combination of ¥32 trillion of liquidity injected into the money markets by the Bank of Japan along with G-7 sales of the yen amounting to at least ¥2 trillion, will reinforce market expectations that while Japanese monetary policy will continue to ease, the policies of both the euro zone and the U.S. are likely to start moving in the other direction.
The bulk of intervention came from the Bank of Japan, as there is essentially no limit to the amount of yen it can sell. Sales by other central banks are capped by the amount of yen reserves they hold in cash rather than securities.
As they have limited ammunition at their disposal, any further coordinated intervention is likely to be designed to take the market by surprise, having the maximum effect for the minimum expenditure.
This should be enough to do the trick.
Not only is policy pointed in the right direction but events since last Friday are also working against the yen.
Immediate fears of a catastrophe at the nuclear point plant at Fukushima in Japan have subsided. Also, the coalition attacks on Libya may have boosted the price of crude oil but have so far failed to trigger a fresh rush into safe havens, a move that has often benefited the yen in the past.
Instead, growing interest in commodity and higher-yielding currencies suggest that investors are once again looking favorably on risky assets.
There is even talk that if this trend continues, the yen could soon find itself serving as a funding currency for carry trades as investors return to selling low-yielders in order to fund their purchases in higher-yielding more risky markets.
If so, the G-7 would have done its job very well.
The yen would weaken and the currency would no longer pose a threat to Japan’s reconstruction efforts as it tries to avoid slipping back into recession after the devastating earthquake and tsunami earlier this month.
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The Source is WSJ.com Europe’s home for rapid-fire analysis of the day’s big business and finance stories. It is edited by Lauren Mills, based in London.
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