DJ Forex Focus: Better Yen Days On the Way

LONDON (Dow Jones)--The recent yen slide looks like it is now truly over.

Only a few days ago, the Japanese currency was still under selling pressure as evidence of global recovery increased and speculation of interest rate hikes elsewhere in the world took their toll.

As yield differentials widened against Japan, the yen was pushed down to nearly an 8-month low against the dollar.

See the dollar's rise against the yen:

However, events this week may well change all that.

First of all, the yen is once again becoming a safe haven as the Greek debt crisis rumbles on with signs that it is spreading to other debtor nations in the region.

If anything, market fears have intensified in the last day or so and investor appetite for risk has fallen even further. Standard & Poors downgrade of Spanish debt Wednesday after downgrades for Portugal and Greece on Tuesday haven't helped.

As the funding conditions of the euro zone go from bad to worse and the euro itself looks vulnerable to even more sharp losses, the yen is finding itself back in favor.

Secondly, the Bank of Japan may also have some good news for the yen when it holds its regular policy meeting Friday.

Despite recent demands from politicians for further fiscal, and even monetary, easing, recent economic data suggests that the Japanese economy might finally be turning the recovery corner.

Retail sales figures on Thursday showing the fastest year-on-year increase in 13 years--a rise of 4.7%--lifted market expectations that the central bank will now signal an end to deflation.

Although the central bank is expected to leave rates where they are, an upgrade to its growth and consumer price forecasts mean that it is unlikely to contemplate any further monetary easing at this stage, despite political pressure from the ruling DPJ party to do just that.

This possible hardening in the Japanese rate outlook could coincide with a softening in the outlook for the U.S.

Although the Fed wasn't expected to change its rates at the policy meeting that ended late Wednesday, there was some talk it could have moved away from its previous dovish stance of suggesting that policy will remain where it is for "an extended period."

In the event, not only did the Fed officials stick to their old line on rates but U.S. money markets lowered their odds for a rate hike this year given the intensifying crisis in the euro zone.

The third leg of yen support is likely to come from China. The Peoples' Bank of China has spent most of this month gradually tightening policy measures to prevent a bubble from developing in the country's property market.

Concern over the impact this will have on general economic growth may have been reflected in the poor performance of the Shanghai Composite Index, which has lagged most other global stock markets for the last few weeks.

However, the policy tightening has also been reflected in increased speculation that the PBOC is edging closer to allowing a yuan revaluation, a move that provides further reason for buying the yen.

All the same, in plotting how far the yen might now recover one other factor has to be taken into account--Japanese investors.

Recent data has suggested that Japanese appetite for foreign bonds in one form or another has been strong--mirroring the rising confidence in the global recovery.

However, it remains to be seen if these yen-negative flows out of the country start suffering too as global concern over events in the euro zone continue to rise.

Early Thursday in Europe, the yen was trading a little higher, with the dollar falling to Y94.03 by 0705 GMT from Y94.11 late on Wednesday in New York.

The euro was also down at Y124.10 from Y124.27.

Despite the downgrade to Spain's credit rating, general sentiment was holding up fairly well, helped by the U.S. Federal Reserve's upbeat statement about the U.S. economy after its policy meeting. This firmer tone was reflected in global stocks with most Asian markets, including the Shanghai Composite Index posting modest gains. Japan was closed for a holiday.

The euro declined to $1.3196 from $1.3203.

Bloomberg TNI FRX POV

   Reuters   USD/DJ    Thomson   P/1066 or P/1074 

(Nick Hastings has covered the foreign exchange markets and industry for over 20 years. Apart from his written commentary and analysis, he also appears on Fox Business News and CNBC television in Europe, Asia and the U.S. He can be contacted on +44-20-7842-9493 or by email: nick.hastings@dowjones.com)