Rich countries’ central banks are on divergent paths. So are their currencies

The Economist

THE Japanese yen has seen dramatic gyrations in its value since the earthquake and tsunami of March 11th. Immediate bets by speculators—or “sneaky thieves”, in the words of one Japanese official—that companies would have to repatriate funds to cover insurance payouts and reconstruction costs led its value to spike following the disaster. Concerned about the impact of a pricey currency on Japan’s post-disaster recovery, the central banks of the G7 countries flooded the market with more than $25 billion of the Japanese currency, sending the yen tumbling by nearly 3% in a single day. It kept on falling, breaching ¥85 to the dollar on April 6th.

The yen is now being buffeted by opposing forces. When risk perceptions among investors rise—for instance, after the announcement on April 12th that the continuing nuclear crisis in Japan was being upgraded to the same level of seriousness as the Chernobyl disaster—upward pressure is applied to the yen. Analysts reckon that currencies like the yen and the Swiss franc, which are traditionally seen as havens in times of trouble, appreciate whenever investors believe that the environment is riskier. Gold, which hit a record nominal high on April 11th, is another beneficiary of this “flight to safety”.

The yellow metal also benefits from fears that loose monetary policy and rising oil prices will unleash inflation. Such concerns, and the response to them by the world’s central banks, lie behind a second, downward source of pressure on the yen—the “carry trade”, in which investors borrow in low-yielding currencies to finance investments in higher-yielding ones.

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Many argue that the European Central Bank’s decision on April 7th to raise the policy rate in the euro area, and the prospect of further rises to come, has reinvigorated the carry trade. An interest-rate gap is opening between currencies like the dollar and the yen on the one hand, where monetary policy is likely to remain ultra-loose, and higher-yielding ones like the euro on the other. This gap may explain the strength of the euro, which has risen against the dollar in recent weeks despite endless euro-zone sovereign-debt worries (see chart).

It also explains the sustained appreciation of the Australian dollar, which has strengthened markedly since the start of the year. The Reserve Bank of Australia (RBA) was among the first rich-world central banks to start raising interest rates after virtually all countries had slashed them during the crisis. Australia’s deep economic linkages to booming China via its commodity exports mean that the RBA is unlikely to reverse its policy stance in the near future.

The Federal Reserve, too, is unlikely to change direction soon, which implies continued dollar weakness. The Fed’s daily index of the dollar’s value against major traded currencies fell to 69.92 on April 8th, the lowest level since May 23rd 2008. Its monthly index of the dollar’s value against major currencies fell in March for the fourth month in a row.

For Americans concerned about their country’s export prospects, the depressed value of the greenback ought to be good news. In February, the most recent month for which trade data are available, the dollar was 4.5% cheaper in real terms than a year earlier. But although America’s trade deficit did fall in February, it was only because exports fell less steeply than imports. That month’s deficit was still $6 billion higher than a year earlier, when Barack Obama announced a plan to double exports in five years. Achieving that will take more than a cheap currency.