Bank of Japan intervenes to prop up the Yen
If you haven’t been following currency markets lately, the US dollar is approaching multi-decade highs. There are a few key reasons why the greenback is so strong:
- Investors like to move their cash and assets to the US in times of global economic uncertainty
- Inflation is a real concern among investors in other economies, and the US, despite inflation looks to have more credibilty among US investors as the Federal Reserve (the US central bank) has no issues now in raising interest rates to fight it.
- The US economy is doing somewhat better than others, as it doesn’t have the weaknesses that some of its peers (Europe, the UK, China) has right now
Together, these forces create a lot of demand for dollars which increases its value. Exchange rates are binary in, that, if one side goes up, the other must go down.
With the dollar strengthening across the board, currencies around the world are weakening. Since most trade happens in USD, it spells bad news for everyone.
For the Japanese central bank (Bank of Japan) the outlook for the yen has raised so much concern that the bankers decided to act.
In the first time since 1998, the Bank of Japan jumped into currency markets last Thursday to boost the yen versus the dollar.
How the Bank of Japan intervened
To do so, the bank bought yen and sold dollars (removing some of the supply of JPY on the market and adding the amount of USD in circulation globally).
This move helped stem losses (at least for now) which should help Japanese importers get the commodities and raw inputs to run their economy.
The Bank of Japan’s move could be the first of many by central banks to weaken the dollar. As great as it is for American tourists traveling abroad, a strong USD makes imports and global trade more expensive (while making exports less competitive). It also adds to inflation.
We’re not in the business of making exchange rate predictions, but there’s a vested interest from governments around the world to weaken the dollar. Even if many central bankers and treasury officials have been skeptical about intervening as recently as this summer, that could change in an instant.
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The Chinese Renminbi also goes down
China’s currency is also feeling the heat of a weak dollar, with the country’s renminbi (CNY) also dropping to lows not seen since 2005 when the People’s Bank of China ended their dollar peg.
China will also likely intervene in the currency markets as, even if a weak CNY is good for exports, it’s bad for US-denominated imports of raw goods and commodities it needs for manufacturing.
The British pound really does want to be equal to the dollar (and that’s not good)
Despite all the currency happenings in Asia, the British pound is by far the biggest winner in the WTF is going on with Exchange Rates?! weekly contest. (Note: this contest doesn’t exist…yet).
The pound sterling’s fall this year has been spectacular to say the least. Since January, the former vanguard of global trade went from GBPUSD* 1.37 to GBPUSD 1.04 on Monday.
This fall from grace is nearly unprecedented. The last time the GBP became so weak was in 1985, which, along with general dollar strengthening, lead to a coordinated global effort to weaken the dollar.
Here are the main reasons the GBP is doing a Marty McFly in going back to 1985.
The UK’s exit from the European Union is still working its way through the British (and European) economy. By losing duty-free access to their largest trading partner, the UK economy is forcing itself to adjust to new economic conditions, with more friction and barriers to trade.
That harms investor confidence in the ability of British companies to continue to grow and the government to generate tax revenue to fund debt.
War and pandemic-lead Inflation
Russia’s war of aggression against Ukraine impacts the entire world. Europe — including the UK — is particularly hard-hit since the continent had an unhealthy dependence of Russian fossil fuels.
Additionally, supply chain issues due to the pandemic caused caused prices for many goods (most of which trade in USD) to rise.
Unlike the EU, though, the UK doesn’t have the economy of scale anymore to gain leverage as a common trading bloc. That means they need to address these issues alone and with less leverage than their neighbors.
The Bank of England began raising interest rates much earlier this year to combat inflation where it could by attempting to cool off demand.
However, those raises weren’t enough to offset price pressures from sectors of the economy outside of its control.
New Tory government tax cuts
Finally las Friday, the newly-formed British government stunned global investors by announcing a surprise tax cut to boost growth. This move was puzzling for a few reasons:
- These tax cuts overwhelmingly support the wealthy. The government is banking on a 1980s-esque “trickle-down” stimulus, hoping that the well-to-do will spend more which benefits everyone. (This policy has serious constraints as we’ve learned over the years). It does little to stimulate the overall economy.
- Cutting taxes has the effect of adding money to the economy. Even if today’s inflation isn’t directly linked to too much cash swishing around, putting more GBP into the market will only worsen inflation since it cancels out interest rate increases.
- The government plans to borrow money to cover the shortfall from cutting taxes. However, with the pound weakening, it wil cost more money for the British government to do so from international investors (as they have to pay back more as a percentage of their economy versus when the dollar was weaker).
On Monday, the currency markets had had enough, comparing the moves to what emerging market countries do, which sent the pound plummeting and the dollar soaring, leading us to where we are today.
Why a weak pound is bad news for everyone but especially the British
A weakened GBP and a strengthened USD is bad news for everyone. An island country like the UK imports many of its goods and services. With a stronger dollar, imports go up in price, which only adds to price inflation.
What’s more is it will cost more for the British government to borrow as they will not only have to repay more on the international market, but global investors will demand a higher interest rate to compensate for the weak pound.
For the rest of us, the GBP collapsing will have impacts on global financial markets. At a time of historic economic uncertainty, we probably could’ve all done without that right now.
*If you’re not familiar with how currency pair naming works, no problem: we have you covered.💪
It works like this: The first code is the one you have. The second one is the one you want and tells you how much its worth in the first one. It’s actually easier if you say in a sentence, so in our example above, you’d say: “1 GBP buy 1.37 USD” or 1 GBP = 1.37 USD.”