The Bank Of Japan Should Stand Back From Market. By Nicholas Hastings

The Bank of Japan would be well advised to sit on its hands.

As upward pressure on the yen intensifies, the temptation for the central bank to intervene is certainly growing.

The yen has now risen to critical levels for Japanese exporters, just as economic sentiment in Japan has started to improve.

But, as recent attempts by the Swiss National Bank to halt the advance of the Swiss franc have shown, market intervention can often prove futile.

The dilemma for Tokyo is certainly a hard one.

Chances are that if nothing is done, the dollar will fall as far as Y85.00 now that it has broken under its key 2010 low of Y87.95.

See how rapidly the dollar has fallen against the yen:



Click Image to Enlarge

This a far cry from the Y90.18 level that Japanese companies budgeted for in their plans for the fiscal year ending next March, according to the new Tankan survey from the Bank of Japan Thursday. This means that the yen has now reached levels where it poses a threat to export profits, just as the Japanese economy was starting to look up.

Unlike its predecessor for the first quarter, this second quarter Tankan survey shows an optimism that pushed the main diffusion index all the way up from -14 to +1.

The problem for the authorities is that the yen has not only risen to critical levels but it is doing so with even more buying pressure than before.

Market concern over the global recovery has risen to new heights this week, with the European debt crisis showing little sign of going away and with new data suggesting that China is slowing down faster than anticipated.

In the past few months, as the dollar has drifted back down from Y95, the move into safe havens have benefited both the yen and the dollar.

But now, as doubts over the U.S. economy grow and the yield on two-year Treasury bonds fall to a new record low, investors are showing less interest in the U.S. currency.

As a result, flows that might well have benefited the dollar previously are now being diverted towards the yen, increasing the risk that the Japanese currency will break through its high for the year against the dollar.

Tokyo officials are certainly aware of this with the country's new senior vice finance minister Motohisa Ikeda admitting Thursday that a weak yen is "a plus" for Japan's export-led economy.

He hinted at intervention with a warning that the government's goal is to prevent "excessive" yen strength.

However, with upward pressure on the currency increasing, Ikeda and his cohorts at the Ministry of Finance may find it best to say or do little more.

More explicit threats and actual intervention itself could well provide speculators with just the excuse they are looking for to buy the yen even more.

And, as the SNB found out to its recent cost, there is little a central bank can do to stop this rally once it starts.

Early Friday in Europe, a recent move out of dollar assets, much to the benefit of the euro and the yen, had stalled as investors now wait to see if the U.S. non-farm payrolls live up to its bad billing. The consensus forecast is for payrolls, which rose by 431,000 in May, to have fallen by 110,000 in June.

Although the reversal is associated with a decline in jobs for census takers, there is rising concern, given other negative data, that the U.S. economy is facing a double dip recession.

Nevertheless, news that the new Australian prime minister had negotiated concessions on a new mining tax, including a reduction to 30% from 40% on profits, helped to improve global sentiment. The bounce was evident in a 0.1% rise in the Nikkei index in Japan.

By 0700 GMT, the dollar was up at Y88.10 from Y87.56 late on Thursday in New York, according to EBS.

The euro was down at $1.2485 from $1.2515 but was up at Y110.00 from Y109.58.