Asia stronger but fretting over yuan, yen

Asia stronger but fretting over yuan, yen

HONG KONG (Reuters): Yen weakness and the chance of a Chinese devaluation reasserted themselves last week as Asia's most sensitive pressure points but analysts said the region is increasingly able to cope with both risks.

Investors focussed on both issues late last week with renewed concern when the People's Bank of China unexpectedly increased U.S. dollar interest rates, making the yuan relatively less attractive and therefore putting it under more downward pressure.

Yen weakness prompted by a shift in Japanese monetary policy is still widely anticipated despite the "no change" statement that emerged from a Bank of Japan policy meeting on Friday.

The statement came just a few hours after Japan released worse-than-expected economic data: Fourth quarter gross domestic product was down 0.8 percent on the previous quarter, the fifth consecutive quarterly contraction.

The poor data will support calls for Japan to print money, monetizing its debt burden, allowing the yen to fall in value and fueling fears of a Chinese devaluation of the yuan.

But if Japan did so, the rest of Asia would react very differently to a declining yen than it has in the past, said Steve Xu, treasury economist at Standard Chartered Bank in Hong Kong.

Rather than falling with the yen, as before, most markets in the rest of Asia would strengthen, he said.

"If there is a genuine move to monetize debt in Japan, Asia should welcome that plan because without a stable Japan we won't see a sustained recovery in Asia," he said.

Regional currencies, no longer part of a U.S. dollar bloc, now enjoy much greater independence from dollar/yen, he said.

And both the Nikkei 225 index and the Hang Seng would ignore yen weakness and trade higher on an improved Japanese outlook.

This signals a dramatic shift in the pronounced correlation between the yen and Asian equities -- until now, one of the most predictable features of Asian market behavior.

"The yen is important for the rest of Asia, but this point should not be overemphasized," ING Barings said. "There are sound reasons to suggest the sensitivities between the yen and the rest of Asia are unlikely to be as extreme as in the last two years."

There has been a similar shift in Asia's view of a Chinese devaluation, economists said.

Six months ago, a rapid yen depreciation prompted widespread fear of a yuan devaluation, something economists said threatened Asia's newly found but fragile equilibrium.

Now, however, Asia is firmly entrenched in its stabilization phase and economists said the region better understands the yuan issue, which resurfaced last week when the People's Bank of China (PBOC) suddenly raised interest rates on U.S. dollar deposits.

"The Chinese aren't going to devalue anytime soon, and if they do it will be for their own reasons... A weakening of the yen would just be an excuse. It wouldn't drive them to it," said Bill Overholt, Asian strategist at Nomura International.

The PBOC's rate move seemed to imply official acceptance of a weaker yuan -- corporations may opt to hold high-yielding U.S. dollars rather than yuan -- just as the market anticipated a stronger Chinese currency. As a linked currency, the yuan will appreciate in line with the U.S. dollar if the yen weakens.

A stronger yuan would exacerbate deflationary pressures within the Chinese economy. But economists said the yuan rate had little bearing on China's decision to lift U.S. dollar rates.

Overholt argued that there is no fundamental reason why a Chinese devaluation should influence any other currency in Asia: Most currencies already reflect domestic conditions, while trade competition between China and the rest of Asia is moderate.

"If China devalues, interest rates in Hong Kong would go up for a few weeks, but it wouldn't break the Hong Kong dollar peg or drag the Korean won down," Overholt said.