After the relative calm of the last few months, we are entering a period of increasing volatility across the currency markets. As risk markets across the developed world have hit new record highs, the currency markets have traded sideways amidst the inertia, and, like waiting for a London bus, two significant announcements turned up on the same day.
First, the Japanese Central Bank suggested a depreciation of the yen had gone far enough for the time being, sparking an immediate rally for the Japanese currency. The yen had seen a 20 per cent tumble in the past six months, making it one of the worst-performing developed market currencies.
Guest post by Alistair Cotton, senior analyst, Currencies Direct
The main policy aim of a lower yen is boosting the competitiveness of Japanese businesses in world markets. But with Japan a large importer of oil, there is only so much a lower exchange rate can do for the economy barring a pick-up in Japanese consumer spending.
The second major announcement came from the US Federal Reserve who caught the market by surprise with their suggestion that asset purchases could be scaled up or down as early as next month’s meeting. While this is unlikely, it did not stop a major sell-off across equity markets in the aftermath. The Japanese equity market lost seven per cent while indexes across Europe and America shed close to two per cent.
One of the main beneficiaries of this could be the euro, which although deeply troubled, is perceived by the market as a safe harbour in the face of increasingly complex and untried monetary policy in America and Japan. The monetary experiment in Japan is unprecedented in size and scope, and its success largely depends on whether it is able to instil confidence amongst the Japanese public that this remains the right course. The US, on the other hand, seems to be reaching the final phase of the QE journey as they grapple with how to remove stimulus without killing the recovery.
Sterling has been deflated in the face of continued criticism of government fiscal policy. The IMF are unconvinced that current austerity measures will deliver the results Chancellor George Osborne is banking on – reducing debt and retaining credibility in financial markets – instead suggesting capital spending on infrastructure should be the main focus over the coming years. Criticism from such a high profile organisation is doing little to aid UK credibility in the markets and such uncertainty is filtering through to UK businesses and consumers who remain subdued.”