Following a sharp sell off for most of 2016, which accelerated after Brexit, GBP/JPY rallied in December thanks to the election of Donald Trump. In 2017, the pair has mostly traded in a range without any clear long-term trend. The exchange rate has repeatedly sold off on political risks (particularly relating to North Korea), while gaining when tensions subside.
In our previous piece on pound sterling, we wrote that the currency was likely to weaken thanks to (1) slowing growth across Europe, (2) excessively bullish speculator sentiment and (3) Brexit-related woes. Thanks to the UK’s significant trading ties with the EU, we wrote that the pound was unlikely to escape a slowdown across the region. Furthermore, speculator positioning in the pound looked ex…
In our previous analysis on the pound, we claimed that the number of catalysts driving the currency’s bullish trend were running out. At the time, we warned that the rally was running out of momentum, but did not see any evidence that would suggest adopting a bearish stance. Following recent weakness in the British pound, we downgraded our longer-term outlook on the currency to bearish on April 2…
The outlook for the pound, while still bullish, is looking less optimistic today. More specifically, factors including the ongoing slowdown in regional growth, lower expectations for a May rate hike, and significant speculator interest in the currency are hampering the rally. Following Brexit, the trade-weighted value of pound sterling (a measure of GBP relative to other currencies) hit an all-t…
In our last commentary on the Japanese yen, we wrote that the currency was looking excessively weak against the euro. In particular, we stated that bullish catalysts driving EUR/JPY were at risk as speculator positioning in both long euro and short yen trades were looking extreme. In addition, we flagged changes to the Bank of Japan’s “yield curve control” program as a potential risk for yen stre…
In early 2017, doubts regarding the integrity of the Eurozone led many to take refuge in the Japanese yen. Unlike the euro, the Japanese yen exhibits classic safe haven characteristics and tends to strengthen during downturns. Following the Brexit referendum vote and US presidential elections, few were willing to bet on opinion polls that predicted Macron’s victory. Similar to political events in…
Japan has suffered from weak growth and inflation since the global financial crisis, and the Bank of Japan has frequently experimented with unorthodox monetary policies. In September 2016, the BoJ decided to directly target long-term interest rates. The so-called “yield curve control” (YCC) program fixed 10-year Japanese government bond (JGB) yields at 0%. If yields deviated from the BoJ’s target…
Significance of the GBP/JPY pair
British pound to Japanese yen is one of the most popular currency pairs amongst speculators. This is because the pair is fairly volatile, traded in large quantities and tends to reflect global risk sentiment. Looking at the pound, the currency tends to appreciate during economic booms while selling off sharply during times of peril. Given the UK’s close economic relationship with the Eurozone, the currency also tends to track the fortunes of the euro. The United Kingdom is the world’s fifth-largest economy. Given the relatively low yield of the yen, the currency tends to depreciate when growth is strong as investors seek higher returns outside Japan. During downturns, the yen tends to appreciate sharply as yen-based investors sell international assets in exchange for the currency. Japan is the world’s third-largest economy (or fourth-largest if one counts the Eurozone as an economic region). As a pair, GBP/JPY tends to be volatile given the underlying characteristics of the yen and the pound. Relative GDP growth rates for the United Kingdom versus Japan are highlighted below:
2005 – mid-2007: The good times
Between 2005 and mid-2007, optimism for global growth was running high. European currencies including the euro and the British pound rallied sharply, while the yen broadly weakened. The yen was particularly weak as the currency was used as a funding currency for the carry trade. When speculators engage in the carry trade, they borrow a currency with low interest rates (such as the yen) and invest the proceeds in currencies that offer relatively higher interest rates (such as the British pound). Thus the yen weakened during this time while the pound strengthened. From around 190 at the start of 2005, GBP/JPY peaked right under 250 in July 2007.
Mid-2007 – mid-2008: Early jitters
Over the summer of 2007, currency speculators began buying back the yen as global GDP growth began trending down. Given that many carry traders employed significant leverage, gains in the yen were magnified as a result. Growing troubles in the US housing market were particularly worrisome, although most believed that troubles in the sector would be confined to the US. Nonetheless, the British pound began selling off given London’s significant exposure to the US banking sector. Between July 2007 and July 2007, GBP/JPY weakened down to 214.
Mid-2008 – mid-2009: The global financial crisis
By the summer of 2008, the domestic US housing crisis had transformed into a global financial crisis. By June 2008, many global currencies including the British pound, euro and the Australian dollar began selling off sharply. Currencies that gained during this time included the US dollar and the Japanese yen. As we wrote earlier, the upheaval in the foreign exchange market was caused by the global US dollar shortage. Prior to the crisis, international banks borrowed heavily in offshore US dollar (Eurodollar) lending markets. Once Eurodollar lenders began doubting the creditworthiness of borrowers, banks were unable to roll-over their US dollar liabilities. As fears grew, the foreign exchange market sensed panic and the US dollar rose sharply as a result.
Looking at GBP/JPY, the pair bottomed in January 2009 around 122. Following a bear market rally, the pair made a long term top around 162 in August 2009.
Mid-2009 – late-2012: The zero interest rate era
Prior to the financial crisis, the yen enjoyed a natural tailwind thanks to very low interest rates relative to major currencies. As described previously, this resulted in the yen being used as a funding currency in the carry trade. Following the crisis, many central banks reduced interest rates substantially (including the Bank of England). Thus interest rate differentials fell, strengthening the yen. Between late 2009 and late 2012, the yen strengthened against most major currencies.
While the Bank of Japan directly intervened in markets four times between 2010 and 2011, this had a limited impact on the GBP/JPY exchange rate. By October 2012, GBP/JPY was trading around 127.
Late 2012 - 2016: BoE and BoJ move in opposite directions
The year 2012 was a tough year for the Japanese economy and its exporters, and the ruling Democratic Party of Japan government was deeply unpopular. The party’s political fortunes worsened after proposing significant increases to consumption tax. Shinzo Abe, the candidate from the Liberal Democratic Party, campaigned on a platform of economic reform. He named his policies “Abenomics” (inspired by Ronald Reagan’s “Reaganomics”) and it contained three specific priorities. Firstly, he called for significant monetary easing. Secondly, he called for a fiscal stimulus package. Lastly, he called for deep economic reforms. As Abe’s popularity rose in the polls, the yen began weakening as a result.
Following his victory in December 2012, the yen began weakening sharply. The next driver for the yen was the appointment of Haruhiko Kuroda as governor of the Bank of Japan in early 2013. In the first Bank of Japan meeting following Kuroda’s appointment, he announced a significant change to the Bank’s policies. Instead of targeting interest rates directly, the BoJ was set to dramatically increase the size of asset buying program. Specifically, he targeted the purchase of Japanese government bonds, corporate bonds and equities. He further pledged the double the size of the Bank’s balance sheet by the end of 2014. By early 2014, GBP/JPY was trading above 170.
By late 2014, GBP/JPY was once again gaining due to yen weakness. This time, the sharp sell-off in global crude oil prices drove the yen down. While the Bank of England had hinted at rate hikes in 2014, the Bank of Japan was firmly committed to monetary easing. After peaking around 196 in June 2015, GBP/JPY ended the year around 170.
2016 – 2017: Brexit and back
Starting in late 2015, GBP/JPY began falling as the outlook for global GDP growth worsened. At the time, safe haven assets such as bonds and gold rallied. In the UK, markets were jittery as an upcoming Brexit referendum threatened the status quo. Prior to the Brexit vote in late June 2016, GBP/JPY traded around 160.
Following Brexit, the pound nosedived against the yen (and against most global currencies). As uncertainty clouded the outlook for British trading relations, the pound adjusted accordingly. Looking at GBP/JPY, the pair made a long-term bottom in October 2016 around 126. At this time, the Bank of Japan once again reverted to targeting interest rates (instead of the size of monetary easing). This time, Kuroda implemented a policy known as Yield Curve Control (YCC). Under YCC, 10-year Japanese government bond yields were fixed at 0% by the Bank’s traders. After the implementation of YCC, the yen became even more sensitive to interest rate differentials.
In November 2016, following the victory of Donald Trump in the US presidential elections, global bond yields rose sharply as markets priced in faster growth and inflation. In response, the yen weakened as Japanese yields were fixed at 0%. GBP/JPY ended 2016 around 144.
In 2017, the yen strengthened at a slow pace while the pound bounced back thanks to improving optimism regarding the Brexit negotiations. At times, we wrote that optimism in the British pound was approaching extremes. On the other hand, yen strength remained at bay thanks to weak guidance from the Bank of Japan. GBP/JPY ended the year around 152.