---- By CHRISTOPHER ANSTEY ----
WASHINGTON (AFX) - The yen is expected to continue declining against the dollar, despite recent consolidation, and could present a currency-policy test for the new Bush administration if its decline deepens or accelerates, analysts said.
"If dollar/yen goes to 130, that wouldn't be a huge test, but if it's like the 1998 (crisis), and the market is a one-way street, with the yen depreciating quickly, that could be the first test (for the Bush administration)," said Jay Bryson, global economist at First Union Corp.
Currency analysts contacted by AFX News widely expect the yen to break below 120 against the dollar over the next three months, due to continued weakness in the Japanese economy, after consolidating under 117 earlier this week.
"The rebound over the last couple of days is more of a technical development than any fundamental move... The underlying situation in Japan is for steady deterioration; we don't see anything dramatic, but we don't see anything positive," said Tim Duy, senior currency analyst at the G7 Group, an independent international economic analysis group. Duy expects dollar/yen to approach 130 in coming months. Bryson sees the dollar in the "mid 120s" over the three-to-six month horizon.
"The Japanese economy is looking a little soft right now," Bryson said.
The slowing U.S. economy is conversely a factor in the yen's weakness, because it means weak export performance for Japan, analysts said.
Because domestic demand in Japan has failed to respond to both monetary and fiscal stimulus, the external sector of the economy has been one of the main drivers of economic activity, along with capital spending.
The softening in other Asian countries' exports to the U.S. will have an additional knock-on effect, as Japanese companies see declining demand in Asian markets for their capital goods exports, noted Marsel Kasumovich, international economist at Goldman Sachs.
"As a result, the external sector of the Japanese economy will be threatened with a more material slowdown, and it's been the external sector that has been critical to the recovery thus far," Kasumovich said.
Kasumovich sees dollar/yen at around 123 in three months. Bryson noted that the moribund domestic sector of Japan's economy leaves it vulnerable to weakness overseas.
Although Bank of Japan governor Masaru Hayami has expressed concern about the yen's weakness being out of line with fundamentals, analysts said Japanese authorities are comfortable with a measured continued depreciation in the yen.
"The balance of opinion that has come out (of Tokyo) over the last while has been for a weaker yen," Kasumovich noted.
"I think they can live with 120-125," said Scott Schultz, senior vice president at Brown Brothers Harriman.
Analysts explained that Japan has few levers left to stimulate its economy, given that the long period of fiscal and monetary stimulus has not been able to spark a self-sustaining recovery.
"The only avenue for stimulus is through a weaker exchange rate," Kasumovich said.
For the time being, the Bush Administration is likely to see no risk to the U.S. economy from a weaker yen.
"It's not a problem for the U.S. ... unless the dollar really got too strong, say above 150," said Michael Rosenberg, head of foreign exchange research at Deutsche Bank Securities.
"The U.S. needs to attract foreign capital, and a strong dollar is good in that regard," Rosenberg said.
The anticipated rise in dollar/yen will not have a big impact on the U.S. trade deficit, he added.
Treasury Secretary Paul O'Neill said last week he is not "alarmed" at the prospect of continued large current account deficits.
Separately, Lawrence Lindsey, the new national economic advisor, has criticised the Clinton Administration's attempts to influence Japanese monetary and fiscal policy, and has urged an "enhanced," cooperative bilateral relationship.
Duy concluded that "they will know that the dollar has to depreciate (and) that Japan has done everything else." Schultz predicted the new administration to have a generally "hands off approach" to the currency.
Goldman Sachs economists agreed with this idea, saying in a research note that the Bush Treasury is likely to have a "flexible" approach towards the dollar.
However, if the yen's decline were to go beyond current forecasts, or depreciate in 1-2 yen moves against the dollar in a single trading session, the Bush Administration would still be likely to respond by intervening to smooth the market's moves, analysts said.
"The yen's depreciation has been mostly orderly, but the market tends to change quickly," Bryson cautioned, predicting that "they would come in" with verbal or market intervention to prevent instability. Schultz said "both in the case of the Japanese, and the Bush Administration, they want to see orderly moves."
"Dollar/yen at 125 might be a level at which comments are made," Schultz said, although he said the market is most likely set to ratchet slowly, without dramatic moves.
Duy said "if we get closer to 130, or there are 1-2 moves in the yen, it would raise eyebrows," and could call into question the impact of rapid yen depreciation on the rest of Asia.
"They'd have to (intervene) at the end of the day," Duy concluded.