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Central banks need to calm disorderly FX markets

  The world’s major central banks urgently need to calm wild swings in major exchange rates, the latest manifestation of a deepening global financial crisis and one which has sent the US dollar and Japanese yen soaring against European and emerging markets currencies.


Foreign exchange analysts said extreme currency volatility, which has seen moves of a staggering 10% on some major rates on Friday alone, could see the Group of Seven or 20 top central banks intervening soon to stabilize world markets.

Japan’s yen soared on Friday against the dollar and euro and one-month implied volatility rates on the dollar/yen exchange rate surged more than 20 percentage points to almost 45%, prompting Japanese Vice Finance Minister Kazuyuki Sugimoto to warn against such rapid and excessive currency moves. As global investors grow fearful of a world recession and intense financial stress, they are cutting cross-border investments everywhere and repatriating money. Japan’s huge external surpluses buoy its yen in that environment.

What is more, central bank interest rates everywhere are expected to fall sharply soon to offset the world slowdown and currencies supported by relatively high nominal interest rates now are suffering disproportionately from the speculation. ING’s chief FX strategist Chris Turner said currency volatility over the last two months had, to a large extent, been a symptom, not a cause, of the global financial crisis. But he added that this week’s spike in volatility now seemed to be exacerbating global asset market declines. “G7 central banks may need to exercise their mandate of ensuring orderly FX markets by intervening in FX markets,” Turner said, adding it could come as soon as today.



Analysts pointed out the 6% collapse in the dollar/yen exchange rate towards 90 per dollar on Friday contributed to a near 10% fall in the Nikkei - which itself has set the tone for sharp losses on European bourses and indications of a Wall St slide too. “The scale and pace of movements in major foreign exchange rates this week have been sufficiently disorderly to justify immediate currency intervention by the authorities,” said Joe Prendergast, currency strategist at Credit Suisse in Zurich.

But Prendergast stressed the need to intervene should also go well beyond the desire for calmer trading and that central banks may need to cap further sharp gains in the dollar that would compound banking and economic stress. “The most overwhelming immediate reason to intervene and provide FX liquidity for the cross-border deleveraging and currency-matching process is to stem the fear and uncertainty that this scale of seemingly counterintuitive currency movements creates,” he said.

But he added that the balance sheets of banks and financial institutions in Europe and around the world were heavily short of dollars due to the currency mismatches created by the huge writedowns of distressed US dollar mortgage assets.  The rising dollar exchange rate exaggerates those losses “Without intervention, dollar gains may escalate, irrespective of fundamental considerations, compounding global financial and economic dislocations,” he added.



The yen extended gains against the dollar and euro on Friday, with the euro down more than 10% to six-year lows on the yen. Earlier the dollar soared to new two year highs versus a basket of currencies and the euro, while sterling hit a six-year low. “Its extreme risk aversion and deleveraging of risky assets ... and we are seeing safe-haven flows into dollar and yen,” said Lee Hardman, currency economist at BTM-UFJ. “A sharp decline in Asian equities have added to negative sentiment.”

Turner at ING said how to execute intervention was a problem. “Policy makers will always prefer strength in numbers, but in which currency pair should intervention take place?” he said. “Should G7 central banks be selling dollars against Europe and Canada, or be buying dollars against yen.”

Analysts said G7 central bankers may be waiting to co-ordinate some response with the International Monetary Fund. The IMF is hurrying to approve by early November a package that would allow certain emerging market economies exchange local currencies for US dollars to ease short-term credit strains, officials familiar with the plans said late on Thursday.

The so-called liquidity swap facility would be available to a group of pre-selected "top tier" emerging market countries -- those that are well-run but may be having difficulties obtaining credit, the officials told Reuters. Leaders from the Group of 20 top economies, including G7 and leading emerging economy governments, are scheduled to meet in Washington on November 15 to discuss a response to the global economic and financial crisis. (Reuters)