Currency watch: Japanese crisis hits markets

There is of course only one story that is grabbing the headlines in the news, financial or otherwise, and that is the ongoing rescue efforts in Japan.

Investors so far have sold the Nikkei 225 hard with the index falling a net 11.2% at the time of writing although the Japanese yen (JPY) has strengthened, with traders betting that repatriation flows and construction spending will increase massively in the coming days and weeks.

The Bank of Japan has also decided to pump JP¥27.8 trillion (US$340bn) into the markets to improve financial stability in the short term. This should increase the yields on Japanese debt, attracting investment.

A similar policy was put in place after the Kobe earthquake in 1995 and three months later USD/JPY had lost near 20% to sit at an all-time low.

While we are not suggesting that a similar move is likely in the coming three months, a strengthening of the yen has to be watched out for.

Japan has of course kept the planned "Days of Rage" in Saudi Arabia, Bahrain and Oman in the shadows but risk in the Middle Eastern and North African region remains.

Protests were held in the three countries over the weekend but the focus of news cameras elsewhere meant that market reaction, so far, has been muted. Oil still remains high however and will continue to do so for a fair while.

A chat about oil naturally leads me into a chat about inflation. UK Producer Price Index is still riding high, with factory input costs hitting near two-year-highs last Friday. The figure did slightly disappoint the market however and hence sterling’s relative weakness in the past week.

We are forecasting a strong CPI figure but continued doubts over the inflation outlook may be enough to see some MPC members hold off on interest rate rises.
 
Jeremy Cook, chief economist at World First foreign exchange, 18.03.2011