10 Feb 2007 17:38 GMT G7 Aims To Curb Carry Trades, Stressing Risk Of Yen Gains
By Paul Hannon
Of DOW JONES NEWSWIRES
ESSEN, Germany -(Dow Jones)- Finance ministers and central bankers from Europe and Japan Saturday launched a concerted effort to curb the growth of carry trades, which European officials believe have been a key factor in pushing the euro to record highs against the Japanese yen on the foreign exchange markets.
Carry trades refer to investments in assets denominated in high-yielding currencies that are funded by low-yielding currencies. With the Bank of Japan's key interest rate set at 0.25%, borrowed Japanese yen are now a popular source of cheap funding for those investments.
European expressions of concern about the yen's recent weakness and the role carry trades have played in pushing the euro higher against the Japanese currency fueled speculation in the foreign exchange markets that action would be taken at a meeting of finance ministers and central bankers from the Group of Seven leading economies here.
The G7's final communique made no reference to the yen, but noted that Japan's recovery is "on track and is expected to continue." G7 members said they "are confident that the implications of these developments will be recognized by market participants and will be incorporated in their assessments of risks."
According to G7 officials briefing later, those statements were intended to draw investors' attention to the possibility that the yen will strengthen and Japanese interest rates will rise as the recovery continues. That would threaten carry trades, since an appreciation of the Japanese currency would cut investors' profits.
In press briefings after their joint statement, some G7 finance ministers and central bankers highlighted those statements with coordinated language that made clear the yen-funded carry trade was their primary target.
"We want markets to be aware of the risks in one-way bets in general," said European Central Bank President Jean-Claude Trichet. "We, in particular, think of carry trades, but not only carry trades."
At exactly the same time, but in a different room, Germany's finance minister delivered a nearly-identical warning.
"We want to strictly stick to one language," Peer Steinbrueck said. "It's the common view of finance ministers and central bankers that markets should be aware of risks stemming from one-sided bets, particularly on foreign exchange markets. This addresses the problem linked in particular to carry trades."
Japanese Minister of Finance Koji Omi added his voice to the chorus.
"Market participants ought to be aware that acting in one direction could bring a risk," he said, referring to some traders view that yen weakness is a sure bet.
Despite Steinbrueck's claim that all G7 members had signed up to the common phrasing, U.S. officials didn't speak about the danger of one-sided bets in general or carry trades in particular. U.S. Treasury Secretary Henry Paulson told reporters that as a general rule he doesn't believe he should ever comment on the value of freely-floating currencies or evaluate particular trading strategies.
The success of efforts to curb the growth of carry trades may depend on how consistently officials stick to the agreed message. European officials felt that their Japanese counterparts departed from an agreed position shortly after the last G7 meeting in Singapore in September, undermining their initial success in talking the yen higher.
An official at a European G7 delegation insisted the lesson from that experience has been learned.
"Believe me, everyone will stick to the current wording, all parties concerned are fully aware of the risks, notably the Bank of Japan," he said.
The mix of an oblique reference in the communique and more direct comments in press briefings may reflect the G7's desire to avoid an overly dramatic reaction in foreign exchange markets. A more direct statement on the yen's value or Japanese interest rates - unlikely in the face of Japanese opposition and U.S. disinterest - could have risked a rapid unwinding of carry trades, sending assets prices into a spin.
Despite the immediate focus on the yen in response to European concerns about a loss of competitiveness in markets in which Japanese exporters compete with their European counterparts, the Chinese yuan remained an ongoing concern for G7 members.
In their communique, they said that "in emerging economies with large and growing current account surpluses, especially China, it is desirable that their effective exchange rates move so that necessary adjustments will occur."
The G7 had previously called on China to allow the yuan greater flexibility to move in response to market forces. The more direct reference to movement in the exchange rate represents a departure from previous statements.
The G7 said it welcomed "China's commitment to rebalance growth."
China's strong record of economic growth in recent years has been driven by an investment boom and exports, while G7 members want the government to encourage stronger consumer demand as part of a shared effort to reduce trade imbalances.
U.S. Treasury Undersecretary for International Affairs Tim Adams described the change in language as a "technical fix." U.S. officials say their message to China hasn't changed, and they continue to believe China should allow the yuan to appreciate in the short term, and move to a freely-floating currency regime in the longer run.
However, European officials pointed out that while the yuan appreciated by 3.4% against the dollar last year, that was partly the result of the greenback's weakness. But the euro is now stronger relative to the yuan than it was when China ended its peg with the U.S. dollar in 2005, and linked its currency to a basket of currencies. In their view, the new stress on the "effective exchange rate" reflects the need for the yuan to strengthen against currencies other than the dollar.
The G7 sounded a generally upbeat note about the outlook for the world economy, noting that growth is more balanced.
"The US economy is experiencing solid activity, while adjusting to a more sustainable growth path," the communique said. "Canada and the UK remain on a strong and balanced growth path. The euro area is experiencing an increasingly broad-based upswing."
They noted that with energy prices falling, inflationary pressures are "moderating," although G7 central bankers said they said they will "remain vigilant."
-Paul Hannon, Dow Jones Newswires, +44 20 7842 9491, paul.hannon@dowjones.com
(Monica Houston-Waesch, Elizabeth Price, Geraldine Amiel, Andrea Thomas, Natsuo Nishio and Dennis McMahon contributed to this report)
(END) Dow Jones Newswires
02-10-07 1238ET |
