The Yen against the dollar

The yen may rise 4.5 percent against the dollar by year-end as a Bank of Japan interest-rate increase will discourage investors from borrowing the currency to buy higher-yielding assets, said Bank of America N.A.

The currency will appreciate after an August rate increase and reach 118 per dollar as so-called carry trades fade, said Tomoko Fujii, head of economics and strategy in Tokyo.

``The yen is likely to enter a moderate upward trend in late summer,'' said Fujii. ``The pace of the BOJ's rate increases will accelerate next year, making the yen carry trade lose its popularity.''

Japanese Vice Finance Minister Hiroshi Watanabe said yesterday the government will ``monitor speculative movement in carry trades,'' adding that they aren't yet a threat to the economy. The New Zealand dollar has climbed 31 percent against the yen in the past year and the Australian dollar 23 percent as investors bought the currencies with money borrowed in Japan.

The yen traded at 123.39 per dollar at 6:22 a.m. in London, from 123.36 in New York yesterday, close to a 4 1/2-year low of 123.75. It was at 165.68 per euro from 165.63 yesterday, when it reached a record low of 166.12.

Bank of America, the second-biggest U.S. lender, predicts Japan's central bank will raise rates in August, January and in the second and third quarters of 2008. Fujii expects the yen to rise to 115 per dollar and Japanese 10-year bond yields to climb to 2.25 percent from 1.895 percent by March 31.

Rate Outlook

The Bank of Japan's 0.5 percent benchmark rate compares with 5.5 percent in the U.K., 5.25 percent in the U.S., 6.25 percent in Australia and 8 percent in New Zealand. Eleven of 17 economists surveyed by Bloomberg News predict the central bank will raise the rate in August after its quarterly Tankan business confidence survey, a second-quarter economic growth report and Upper House elections in July.

``Global liquidity will be slowing and risk appetite will be moderating,'' Robert Sinche, head of global currency strategy in New York at Bank of America, said yesterday in Tokyo. ``The carry trade environment starts to get a little less positive as we go through the second half.''

The yen has gained an average of 3 percent in August over the eight years from 1998 to 2005, as Japan's investors, the largest international holders of Treasuries, received semi- annual interest payments from the U.S. government.

The jinx on yen gains in August was broken last year, as Japanese life insurance companies hadn't aggressively added to holdings of Treasuries for months, said Fujii.

``Unlike last year, life insurance companies this year have actively bought foreign bonds, so I bet the theory on the yen's August gains will revive,'' Fujii said. ``The BOJ's rate hike in August may further increase the chances of it.''

Low Volatility

Toru Umemoto, chief foreign-exchange strategist in Tokyo at Barclays Capital, is more bearish on the yen, predicting it may fall to as low as 127 by the end of the year.

``Yen carry trades will prevail,'' said Umemoto, who was the most-accurate yen forecaster last year in surveys by Bloomberg News. ``Japanese investors are buying growth-focused foreign stock-investment trusts such as on emerging economies.''

Implied volatility on one-month dollar-yen options on June 5 fell to 5.85 percent, the lowest since the Bank of Japan began compiling data in August 1992, compared with 10.15 percent on March 5. Lower volatility may encourage carry trades, as it implies less exchange-rate fluctuation risk.

Bond Yields

Osamu Takashima, chief analyst of the global markets sales and trading division at Bank of Tokyo-Mitsubishi UFJ Ltd. in Tokyo, also predicts the yen may rise to 118 a dollar by year- end as the yield gap between Japanese and global debt narrows.

The spread for benchmark two-year U.S. and Japanese bonds, the most sensitive to monetary policy changes, today stayed near a three-week low of 3.92 percentage points. The Japanese government should prepare for a gradual rise in interest rates, Finance Minister Koji Omi said on June 8.

``Yield gaps will be heading in one direction,'' said Takashima. ``As the BOJ normalizes its rate policy, it will also raise volatility. This is favorable for the yen.''

source:www.bloomberg.com