Today’s Nikkei daily newspaper reports the Japanese government has begun to consider purchasing additional EFSF bonds, and Chief Cabinet Officer Fujimura (the PM’s spokesperson) confirmed the general idea. Although details of past purchases have not been disclosed, Japan reportedly purchased about EUR2.6bn worth of EFSF bonds in January and June, roughly 20% of total issuance of EUR13bn according to the Nikkei daily, in line with what the Japanese government announced in January.
The impact on EUR would depend on the size of additional purchases and how these purchases will be financed. In the past cases, it seems that the direct impact has been neutral as the purchases were financed by EUR liquidity already held in Japan’s FX reserve. However, as Japan has seemingly used up EUR2.6bn for EFSF bond purchases within its estimated EUR deposit holdings (max EUR2.7bn according to our estimate in What is the EUR share of Japan’s official FX reserves? on 31 January), additional EFSF bond purchases should be done either by 1) selling other EUR-denominated assets, which is not very consistent with Japan’s intention to help stabilize European financial situation, 2) selling other currencies like USD, and/or 3) JPY funding, the same process as the EUR buy/JPY sell intervention. Although Japanese government officials have not commented on this point yet, it is growing likely that the funding will be in JPY, in our view. Although European officials – ECB President Trichet for instance – have been critical of Japan’s FX intervention, the Euro area may not show its discomfort as directly as before, as Japan is trying to help Euro area.
In such a case EUR/JPY may be supported to some extent. In terms of the size, however, it may not have a lasting impact (daily global transaction volume of EUR/JPY amounts to EUR83bn according to the latest BIS survey in April 2010), if Japan keeps its past size of purchases per auction (20% of total, about EUR0.6-1.0bn).
More importantly, the purchase may not be timed successfully to reduce the current downside EUR risk. According to the Nikkei article, Japan has just started considering it and thus the decision may not be imminent. In addition, Japan’s EFSF bond purchases will be decided upon on the condition that the Euro area makes progress on giving the EFSF stronger powers, which will not be approved by all the Euro area member countries until at least next week. The delay in the sixth disbursement of lending for Greece and the potential renegotiation of private sector involvement in Greek debt restructuring may postpone Japan’s decision as well.
Accordingly, we think that EUR/JPY is likely to fall further, as the Euro area progress in solving the Greek problems is delayed (Barcap forecasts: 1m 100yen, 3m 94yen).
We think EFSF bond purchases funded in JPY are less problematic in terms of currency diplomacy than simple EUR/JPY intervention, but EUR/JPY intervention by Japan may happen, should a further fall of EUR/JPY below 100 yen cause a large decline in the Nikkei to the 8,000 yen level, and worsen the Japanese economic outlook significantly. Even in such a case, JPY selling intervention is likely to be concentrated vs USD as the pair’s liquidity is larger than EUR/JPY ($568bn for USD/JPY vs $111bn for EUR/JPY, according to a BIS survey in April 2010) and USD/JPY intervention should have a larger ‘spillover effect’ to other yen crosses than is the case for EUR/JPY intervention.
Figure 1: EUR/JPY and Nikkei
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