Fresh yen high 'feels like 145 to the dollar'

By Alex Frew McMillan
CNN Hong Kong

TOKYO, Japan (CNN) -- The yen continued its recent run against the dollar, weakening to a fresh three-year high against the dollar on Thursday.

It took the market by surprise in morning trade, breaking sharply higher and through resistance to hit 128.79 against the greenback.

One currency strategist told CNN that deflation in Japan and mild inflation in the U.S. in recent years made the current yen rate feel like 145 to the dollar.

The Japanese currency had strengthened after Wednesday's moves by the central Bank of Japan, which tried to inject more cash into the economy.

But Finance Minister Masajuro Shiokawa prompted Thursday morning's move.

Bond cap might not hold

Shiokawa said he was not sure the government's 30 trillion yen cap on government bonds would hold in the business year starting April 2003.

That cap is the cornerstone of Prime Minister Junichiro Koizumi's pledge to rein in government spending.

His ministry released a draft budget for that year on Thursday. It caps new JGBs, or Japanese government bonds, at that level.

The draft for fiscal 2003 cuts government spending by 1.7 percent, to 81 trillion yen ($633.6 billion), a second straight fall.

"We have to watch the situation," Shiokawa said, when asked if the cap could hold. He said his basic stance is that the government shouldn't easily resort to new bonds to bail out Japan.

Poor economy the root cause

But the poor state of Japan's economy, now in its fourth recession in a decade, has been the root cause of the yen's weakness.

"What is weighing on the yen is broader concern heading toward the fiscal year end, broader concern about the banking sector," said James Malcolm, a foreign-exchange strategist with J.P. Morgan in Singapore.

The yen has raced from 121 against the dollar to 128 in less than a month, with a speed that has bothered officials.

That's a three-year high. But when adjusted for inflation, Malcolm believes the yen's real exchange rate is much weaker.

Japan has suffered deflation over the past three years, and U.S. prices have risen with mild inflation. So a yen that's now at 130 to the dollar is actually the equivalent of 145 to the dollar back in 1998, he said.

"Dollar-yen being at 130 now is equivalent to 145 a couple of years ago -- we've already got a considerably weaker yen than it appears because of deflation," Malcolm said.

No more sudden moves expected

On Thursday, a sudden spurt in dollar buying broke through a resistance level at 128.50, and the Japanese currency is likely to rise to 129.

But Malcolm does not expect it to go much higher, though. The yen's move in the last month has already been dramatic.

So he thinks other estimates that the yen might rise to 140 against the dollar, or even to 170 by the end of 2002, are overdone.

"It's very easy to get carried away when we've come such a distance in less than a month," Malcolm said.

Sudden moves in any country's currency undermines confidence in the financial system. They pose problems for companies and investors doing business with or in that nation.

In the long run, though, a weaker yen makes Japanese goods cheaper overseas. So ministers are thought to be happier with a yen nearer 130 to the dollar than 120.

It would take a true bank crisis hitting Japan, coupled with signs of an early U.S. recovery that strengthened the dollar, for the yen to break out much further, Malcolm said.

The central Bank of Japan also did its part to help Japan's economy on Wednesday, by easing monetary policy.

The BOJ raised the amount of government bonds it buys every month to 800 billion yen ($6.25 billion), from 600 billion yen. It also raised the target for current-account deposits to between 10 and 15 trillion yen.

Those moves to inject cash into Japan's economy would normally weaken a currency. But similar steps have done little to spur bank lending in the past few months, and traders expected an easing in monetary policy. So they had little effect on the currency this time.

Reuters contributed to this report.