Fears over sub-prime difficulties spread outside the US on Thursday and this triggered a sharp unwinding in carry trade positions. The yen move was amplified by stop-loss selling after the dollar weakened through the moving average support. A tightening of global lending standards and reduction in credit supply will cut securities issuance and will also tend to reduce the flow of Japanese funds into overseas bonds which will strengthen the capital account.
Japanese core consumer prices fell 0.1% in the year to June which dampened expectations of an August interest rate increase. The chances of an August rate increase were cut to around 50%. Attention in the short term is likely to remain fixed firmly on global market conditions and carry trades. Japanese investors continued to sell the yen on rallies, but the dollar was struggling to hold above 119.0 in Asia on Friday with a temporary retreat back to 118.50 and a key feature is likely to be increased volatility.
Further rapid yen gains would be likely to trigger verbal intervention by Japanese financial officials and yen selling by Japanese institutions to stabilise markets.