China Fears Add To Yen's Growing Woes. By Nicholas Hastings

The scales appear to be gradually tipping against the yen.

So much so that the Japanese currency, which has been holding steady for most of this year against other major currencies, could finally sink.

See the yen's fairly steady progress against the dollar so far this year:


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The Bank of Japan could well start the process next week if it decides to reverse back into full scale quantitative easing as many expect.

This will merely highlight to the investment community the rising deflationary risks that remain in Japan, which will ensure that while most other major economies are contemplating a hike in interest rates, the Japanese are being forced to keep on easing.

The problem for Japan was driven home by Thursday's data which showed that while the country's fourth-quarter growth estimate of 0.9% might still be one of the largest in the Group of Seven leading industrial nations, with consumer spending improving, consumer prices are still falling and deflation is now as deep as 2.8%.

These figures coincided with news from Beijing that Chinese inflation was up at a higher-than-expected 2.7% last month and more speculation that the Peoples' Bank of China will soon have to start raising rates. Either that or it will have to allow the yuan to appreciate.

Either way, this would probably be bad news for the already fragile global recovery and even worse news for Japan's chances of escaping deflation.

But there are a few other reasons why investors might find the yen less palatable now than they did before.

The first of these is the Japanese investor. For months, the Japanese have obviously been more interested in the higher yields available abroad. But, up until now, they have hedged these flows, ensuring that the impact on the yen was minimal.

But, as rate hikes look likely elsewhere, the need to hedge these flows won't be so acute.

"The unwinding of quantitative easing in the U.S. and increasing speculation of monetary tightening will reduce the incentive to hedge U.S. bond portfolios, suggesting dollar/yen will rally," said the currency strategy team at BNP Paribas SA.

Then there is the issue of risk.

As a safe haven, the yen has benefited from concern over the last month or two that the global economy isn't rebounding as quickly as initially expected.

Now though, market sentiment is shifting and risk is becoming less of a market driver. As global recovery data have started to surprise on the upside, investor confidence has risen and safe havens, such as the yen, have lost some of their allure.

Finally, there is the Japanese government. As it continues to battle against deflation, the last thing Japan needs is a strong yen. In recent weeks, the Ministry of Finance has hinted that it is preparing a war chest for intervention, the threat of which will only discourage yen bulls from continuing to buy the currency at this stage.

Earlier Friday Prime Minister Yukio Hatoyama joined the fray, complaining that overseas financial crises "have brought about a strong yen that we don't believe reflects the fact that Japan's economic and industrial conditions aren't strong enough."

"I think we need to take firm steps against such yen strength," the prime minister added.

With rumors circulating that China could hike rates as early as this weekend, it is little surprise that the yen fell back down a little, with the dollar rising to Y90.61 by 0745 GMT from Y90.56 late Thursday in New York, according to EBS.

The euro was also up at Y124.10 from Y123.86 as well as at $1.3694 from $1.3679.