Yen Falls as China Stock Gains Boost Confidence in Carry Trades

By Kosuke Goto

Aug. 20 (Bloomberg) -- The yen fell against the dollar and euro as stock gains in Europe and Asia encouraged investors to buy higher-yielding assets funded in the Japanese currency.

The yen also declined against the Australian and New Zealand dollars, favorites of so-called carry trades, as China's benchmark stock index jumped the most since April. The British pound traded near a two-year low on speculation minutes of the Bank of England's last meeting, released today, will signal policy makers expect inflation to slow.

``It was a big surprise to see Chinese stocks surging,'' said Ryohei Muramatsu, manager of Group Treasury Asia in Tokyo at Commerzbank AG, Germany's second-largest bank. ``This boosts risk appetite, prompting yen selling.''

The yen was at 110.07 against the U.S. currency at 8:20 a.m. in London, from 109.72 yesterday in New York. The Japanese currency traded at 162.26 per euro from 162.13. The dollar was at $1.4740 per euro, from $1.4776 yesterday, when it touched $1.4631, the strongest level since Feb. 20.

Japan's currency may fall to 110.30 per dollar and 162.50 a euro today, Muramatsu forecast.

The yen declined 0.3 percent to 78.51 against New Zealand's currency and 0.2 percent to 95.87 versus the Australian dollar, as China's CSI 300 Index, which tracks yuan-denominated A shares listed on China's two exchanges, climbed 7.9 percent.

The pound fell against the dollar to $1.8616 from $1.8670. It slipped to $1.8512 on Aug. 15, the lowest level since July 2006.

`Trade War'

JPMorgan Chase & Co., the third-largest U.S. bank, predicts the Bank of England will lower its benchmark 5 percent interest rate as early as November, a change from its previous estimate of February 2009. The Bank of England releases its minutes at 9:30 a.m. in London.

The yuan climbed 0.16 percent to 6.8534 a dollar, the most in three weeks, after U.S. Treasury Secretary Henry Paulson urged China to let its currency appreciate to curb inflation.

Paulson said yesterday on a conference call hosted by Foreign Affairs magazine that measures in Congress to punish China for depressing the value of the currency might spark a ``trade war'' that would be unproductive.

The yen also weakened on speculation the Bank of Japan will keep interest rates at the lowest level among industrial nations over the coming year. The central bank cut its economic assessment, saying growth in the world's second-largest economy is ``sluggish'' for the first time in 10 years, according to its monthly economic report released in Tokyo today.

Bank of Japan

The Bank of Japan yesterday kept its target lending rate at 0.5 percent, supporting demand for carry trades. By comparison, New Zealand's benchmark rate is 8 percent, Australia's is 7.25 percent and the Federal Reserve's target is 2 percent.

In carry trades, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the rates. The risk is that currency market moves can erase those profits.

Bank of America Corp. lowered its forecast for the yen as the bank pushed back its estimate for a BOJ interest-rate increase from April 2009 to July 2009. The currency will fall to 110 per dollar by year-end and to 112 by March 31, versus earlier forecasts of 108 and 109, Tomoko Fujii, Tokyo-based head of economics and strategy for Japan at the second-largest U.S. bank, wrote in a research note.

Rates, Risk Appetite

``The Japanese yen price action remains dominated by relative interest-rate expectations as well as risk appetite developments,'' she said. ``In our judgment, the Fed will probably begin to hike rates earlier and more aggressively than the BOJ.''

There is a 1 percent chance the BOJ will reduce borrowing costs to 0.25 percent by the end of September, according to calculations by JPMorgan Chase & Co. using overnight interest- rate swaps. The odds for a cut by year-end are 11 percent.

Any gains in the dollar may be limited by speculation credit-market losses at U.S. financial firms will deepen and as crude oil prices rose, raising concern that the nation's economic slowdown will be prolonged.

``The U.S. credit-market turmoil won't settle down any time soon,'' said Yuji Saito, head of the foreign-exchange group in Tokyo at Societe Generale SA, France's second-largest bank by market value. ``Rising oil prices also weigh on the dollar. I am a dollar bear.''

The U.S. currency may decline to 109.10 yen and $1.4850 a euro today, Saito forecast.

Crude Oil

Crude oil fell, trading at $114.64 a barrel. The euro-dollar exchange rate and oil had a correlation of 0.9 in the past year, according to Bloomberg calculations. A reading of 1 would mean they move in lockstep.

Lehman Brothers Holdings Inc., the largest underwriter of mortgage bonds before the subprime market collapsed, may write down about $4 billion in credit-related investments and other assets when it reports fiscal third-quarter earnings, JPMorgan Chase analysts said Aug. 18. Goldman Sachs Group Inc. said yesterday it's ``increasingly likely'' American International Group Inc., the biggest U.S. insurer by assets, will have to raise more capital.

Futures on the Chicago Board of Trade show a 20 percent chance the U.S. central bank will raise the 2 percent target rate for overnight lending between banks by at least a quarter-point by its Dec. 16 meeting, down from 37 percent odds a week earlier. Policy makers next meet Sept. 16.

To contact the reporter on this story: Kosuke Goto in Tokyo at kgoto2@bloomberg.net