FX COLUMN-Turning Japanese? Euro zone exporters must hope not
– Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own –
By Neal Kimberley
LONDON, March 14 (Reuters) – Euro zone exporters must be hoping European Central Bank (ECB) President Mario Draghi is right when he rejects comparisons between the currency bloc and Japan’s experience of deflation.
Or, just as Japanese exporters discovered for long periods in the 1990s, today’s euro zone exporters might suffer as a strengthening local currency eats into their bottom line and gives their global competitors an edge.
The euro hit a 2-1/2-year high of 1.3967 to the dollar on Thursday and has jumped almost 5.5 percent versus the offshore yuan hitting 8.5674 on Thursday from 8.1239 as recently as Feb 6.
The euro’s rise has even registered on Draghi’s radar.
The euro exchange rate was “becoming increasingly relevant in our assessment of price stability,” Draghi said Thursday, firing a shot across the bow of traders holding long euro positions in expectation of further gains.
Any further gains would be particularly unwelcome to euro zone exporters. As natural buyers of euros to hedge sales made outside the currency bloc, the cheaper the euro the better, as margins and competitive pricing advantages accrue.
Equally, the stronger the euro, the tougher it gets for euro zone exporters to compete in a global marketplace, as euro-priced products become more expensive in local currency terms, and margins are shaved in an attempt to stay competitive.
As Japan grappled with deflationary pressures through the 1990s, the yen appreciated from 146.73 to the dollar on Jan. 2, 1990 to close the decade at 102.21 on Dec. 31, 1999.
There were many thrills and spills along the way but essentially Japan’s exporters had to come to terms with a yen that was significantly stronger by the end of that decade than it had been at the beginning.
Draghi has been insistent that the situation in the euro zone is different to that faced by Japan in the 1990s.
Others have seen similarities between Japan’s experience and what is happening in the euro zone.
A Japanese banking sector beset by asset price deflation in the 1990s battened down the hatches and reined in new lending.
The euro zone banking system, particularly as regards loan exposures, is going through its own period of consolidation, involving repatriation of euros – a process not necessarily conducive to an expansion of fresh credit to the wider economy.
As Japanese banks looked inwards, capital invested offshore came home in the 1990s to bolster yen-denominated balance sheets, with such repatriation flows supporting the rise of the Japanese currency over time.
Simultaneously, recognising what was occurring, Japanese exporters learned to buy their yen for hedging today, because the odds were it would be more expensive tomorrow.
Both Japanese importers, natural sellers of yen to generate foreign currency, and Japanese investors, looking to invest offshore, realised they could defer selling yen today.
For them, the odds were that the foreign currency would likely be cheaper in yen terms tomorrow than today.
The idea that the yen would be worth more in 24 hours almost became a self-fulfilling prophecy.
If Draghi is wrong and there are parallels between 1990s Japan and the present-day euro zone, the currency bloc’s exporters might have a lot more to worry about than whether or not to add hedges at what are already unattractive levels.