The dollar’s broad weakness helped the euro to trade firmly
and sterling to extend gains to a six-week high, yet traders
remained reluctant to chase those advances with more signs of
fragile economic recovery tempering appetite for risky positions.

“The dollar is clearly under pressure after the FOMC
indicated that interest rates will not rise anytime soon. But
there is no other currency good enough to buy against the dollar
either,” said Nobuhiko Akai, senior manager of the forex trading
group at Bank of Tokyo-Mitsubishi UFJ.

“The euro’s limited gains against the dollar reflect
deep-seated market concerns about more bad news from the region’s
debt or banking sector.”

The Aussie AUD=D4 rose as high as $0.8771 after Australia’s
ruling Labor Party elected a new Prime Minister in Julia Gillard,
in a bid to avoid election defeat later this year.
[ID:nSGE65M0LY]

“Clearly this is a positive for the Australian dollar and
stocks in the short and medium term,” said Su-Lin Ong, a senior
economist at RBC Capital Markets.

“It removes the political uncertainty that had been growing
and would have only got worse. We assume Gillard will negotiate
on the mining tax and produce a watered-down version.”

Gillard immediately offered to end a bitter dispute over a
controversial “super profits” mining tax, saying she would throw
open the door for fresh negotiations. But she stressed miners
should pay more tax. [ID:nSGE65M0LY]

The Aussie later trimmed gains to stand at $0.8742, steady
from late U.S. trading on Wednesday.

The U.S. dollar was on the backfoot after the Fed softened
its view on the U.S. economy in its statement, noting pockets of
weakness in certain sectors and warning against volatile
financial markets given the euro zone debt crisis.

For the Fed statement, double-click on [ID:nTRU002480]

The interest rate futures market is pricing in the Fed’s next
rate increase by the middle of next year.

The dollar index .DXY dipped 0.1 percent to 85.694 after
posting an outside day reversal the previous day, suggesting more
losses might be in store.

Sterling rose to $1.5001 GBP=D4, the highest since May 12,
extending gains made the previous day after a hint of an early
rise in interest rates in the Bank of England’s minutes. After
trimming some gains, sterling stood at $1.4979 for a gain of 0.1
percent on the day.

Its rise on Wednesday pushed sterling up above the cloud on
daily Ichimoku charts, a bullish signal for the currency.

Sterling is now likely to find support at the top of the
cloud at $1.4876, while facing resistance near $1.5000 and
$1.5050, said Hiroyuki Tanaka, chief technical analyst at Mizuho
Corporate Bank.

Against the yen JPY=, the dollar stood at 89.87 yen, stuck
near a one-month low of 89.73 yen hit on Wednesday on trading
platform EBS.

The dollar was undermined as U.S. Treasury yields fell with
data showing sales of new U.S. single-family homes tumbling more
than expected in May.

The euro rose 0.2 percent to $1.2331 EUR=.

China’s central bank set the yuan’s daily mid-point at 6.8100
per dollar on Thursday, little changed from Wednesday’s close,
and shrugged off renewed calls by U.S. lawmakers for legislation
to press China to allow the yuan to appreciate. [ID:nECB000555]

Major currencies showed muted reaction to the yuan as the
yuan-linked trading fad faded after choppy price actions earlier
this week following China’s initial announcement on yuan
flexibility.
(Additional reporting by Anirban Nag in Sydney and Masayuki
Kitano in Tokyo; Editing by Joseph Radford)

The dollar’s broad weakness helped the euro to trade firmly and sterling to extend gains to a six-week high, yet traders remained reluctant to chase those advances with more signs of fragile economic recovery reducing appetite for risky positions.

“The dollar is clearly under pressure after the FOMC indicated that interest rates will not rise anytime soon. But there is no other currency good enough to buy against the dollar either,” said Nobuhiko Akai, senior manager of the forex trading group at Bank of Tokyo-Mitsubishi UFJ.

“The euro’s limited gains against the dollar reflect deep-seated market concerns about more bad news from the region’s debt or banking sector.”

The Aussie rose as high as $0.8771 after Australia’s ruling Labor Party elected a new Prime Minister in Julia Gillard, in a bid to avoid election defeat later this year.

That stirred hopes the government would dilute a controversial mining tax that had unsettled offshore investors.

“Clearly this is a positive for the Australian dollar and stocks in the short and medium term,” said Su-Lin Ong, a senior economist at RBC Capital Markets.

“It removes the political uncertainty that had been growing and would have only got worse. We assume Gillard will negotiate on the mining tax and produce a watered-down version.”

The Aussie later trimmed gains to $0.8748, up 0.1 percent on the day.

The U.S. dollar was on the backfoot after the Fed softened its view on the U.S. economy in its statement, noting pockets of weakness in certain sectors and warning against volatile financial markets given the euro zone debt crisis.

The interest rate futures market is pricing in the Fed’s next rate increase by the middle of next year.

The dollar index .DXY dipped 0.1 percent to 85.66 after posting an outside day reversal the previous day, suggesting more losses might be in store.

Sterling edged up to $1.4994, the highest since May 12, extending gains made the previous day after a hint of an early rise in interest rates in the Bank of England’s minutes.

Against the yen, the dollar was near a one-month low around 89.92 yen, though dealers said there were buy orders underneath from Japanese importers.

The dollar was undermined as U.S. Treasury yields fell with data showing sales of new U.S. single-family homes tumbling more than expected in May. It fell as low as 89.73 yen on Wednesday.

The euro rose 0.2 percent to $1.2337, but was capped a tad below Wednesday’s high of $1.2344.

Traders said the euro held gains despite a deterioration in Greek-German yield spreads which widened 60-70 basis points across the curve.

But the euro is also likely to be restrained by news that borrowing by Portuguese banks from the European Central Bank doubled in May to a record 35.8 billion euros ($48.03 billion), highlighting their reliance on ECB funds.

China’s central bank set the yuan’s daily mid-point at 6.8100 per dollar on Thursday, little changed from Wednesday’s close, and shrugged off renewed calls by U.S. lawmakers for legislation to press China to allow the yuan to appreciate.

Major currencies showed muted reaction to the yuan as the yuan-linked trading fad faded after choppy price actions earlier this week following China’s initial announcement on yuan flexibility.

(Additional reporting by Anirban Nag in Sydney; Editing by Joseph Radford)

Spot yuan rose to its highest level since its revaluation
five years ago, helping to reinforce market optimism that a
pledge from China on yuan flexibility would help reduce the
global imbalance, encouraging sustained global growth and
supporting higher-yielding and riskier assets. [ID:nBJD003795]

“China’s commitment to allowing more yuan flexibility is
definitely an encouraging factor for stability in the market,”
said Hideki Amikura, deputy general manager of the forex section
at Nomura Trust Bank.

“It is a sign that China is ready to act responsibly to fix
global imbalances and avoid potential international conflicts,”
he said.

The yuan rose as high as about 0.4 percent to 6.8015 per
dollar CNY=CFXS after China broke away from its 23-month-old
currency peg.

That was enough for the the Aussie and the euro to recover
from initial disappointment after China set the yuan’s daily
mid-point CNY=SAEC at 6.8275 against the dollar on Monday,
unchanged from last Friday, the day before Beijing said it would
allow the yuan to trade more flexibly.

“You can’t gauge Beijing’s stance on the yuan just from
today’s mid-point. Obviously we will have to see how much yuan
appreciation they allow for the time being,” said Shuichi
Kanehira, head of forex spot trading at Mizuho Corporate Bank.

The Aussie AUD=D4 gained 1.2 percent to around $0.8824,
rising as high as $0.8830, a one-month peak.

The New Zealand dollar NZD=D4 also rose nearly one percent
to $0.7121, after having climbed to a five-week high of $0.7140.

The euro EUR= gained to $1.2457, up 0.6 percent. It earlier
marked a four-week high around $1.2490 in early Asian hours.

The dollar gained 0.1 percent to 90.77 yen JPY=, rebounding
higher from an earlier three-week low of 90.01 on trading
platform EBS.

Westpac senior currency strategist Imre Speizer said for a
variety of reasons the yuan weekend statement was seen as
positive for commodity currencies such as the Australian and New
Zealand dollars, including the prospect of improved exports to
China.

“This move may also have been designed to reduce friction at
the G20 meeting involving trade issues,” Speizer said.

The yuan’s value had been seen as a potential point of
conflict at the Group of 20 summit in Toronto on June 26-27, as
Washington pressed for moves to a market-based exchange rate,
while Beijing had said the currency was its own business and
outsiders should not meddle.

Scott Haslem, chief economist at UBS in Sydney saw the dollar
reaching 6.55 yuan by year end, with this appreciation of between
3 and 4 percent likely achieved in the next few weeks.

A more flexible yuan would lessen the threat of a Sino-U.S.
trade war, which could have been a danger to global growth, and
enable China to buy more commodities, or at least cope better
with higher commodity prices, a positive for big resource
exporters like Australia and New Zealand.

A higher yuan would also help temper inflation in China by
pushing down import prices, which in turn could mean Beijing
would have less need to tighten monetary policy aggressively.

Markets have been worried China could over-tighten and slow
its economy too far.

Breaking the peg might mean China needs to buy less U.S.
dollars in intervention, which would leave it with fewer dollars
to buy U.S. Treasuries, but also less need to diversify its
holdings into currencies like the euro.
(Additional reporting by Gyles Beckford in Wellington; Editing
by Joseph Radford)

China’s central bank set the yuan’s daily mid-point
CNY=SAEC at 6.8275 against the dollar on Monday, unchanged from
last Friday, the day before Beijing said it would allow the yuan
to trade more flexibly.

This initially disappointed some market players who had
expected a strengthening of about 0.5 percent for Monday’s
central bank fixing after the country indicated it was ready to
break a 23-month-old U.S. dollar peg that had come under intense
fire from abroad.[ID:nSGE65I02M]

But Spot yuan rose to its highest since 2008 against the
dollar, and market optimism remained that China’s pledge on yuan
flexibility was a vote of confidence in the global economic
recovery’s staying power, helping higher-yielding and riskier
assets such as the Australian dollar and U.S. stock futures to
hold strength, traders said. [ID:nBJD003795]

“China’s commitment to allowing more yuan flexibility is
definitely an encouraging factor for stability in the market,”
said Hideki Amikura, deputy general manager of the forex section
at Nomura Trust Bank.

“It is a sign that China is ready to act responsibly to fix
global imbalances and avoid potential international conflicts,”
he said.

The Aussie AUD=D4 retreated from its earlier high around
$0.8830, a one-month peak, after the yuan mid-point was
announced, but held firmly at $0.8806 AUD=D4, up 1 percent on
the day.

The New Zealand dollar NZD=D4 also cut an earlier 1.2
percent rise to a five-week high of $0.7140, but was still up 0.7
percent at $0.7105.

The euro EUR= stood at $1.2431, up 0.4 percent, after
briefly pulling back from a high around $1.2490 traded in early
Asian hours.

The dollar gained 0.1 percent to 90.77 yen JPY=, rebounding
higher from an earlier low of 90.01 on trading platform EBS.

Westpac senior currency strategist Imre Speizer said for a
variety of reasons the yuan weekend statement was seen as
positive for commodity currencies such as the Australian and New
Zealand dollars, including the prospect of improved exports to
China.

“This move may also have been designed to reduce friction at
the G20 meeting involving trade issues,” Speizer said.

The yuan’s value had been seen as a potential point of
conflict at the Group of 20 summit in Toronto on June 26-27, as
Washington pressed for moves to a market-based exchange rate,
while Beijing had said the currency was its own business and
outsiders should not meddle.

Scott Haslem, chief economist at UBS in Sydney saw the dollar
reaching 6.55 yuan by year end, with this appreciation of between
3 and 4 percent likely achieved in the next few weeks.

A more flexible yuan would lessen the threat of a Sino-U.S.
trade war, which could have been a danger to global growth, and
enable China to buy more commodities, or at least cope better
with higher commodity prices, a positive for big resource
exporters like Australia and New Zealand.

A higher yuan would also help temper inflation in China by
pushing down import prices, which in turn could mean Beijing
would have less need to tighten monetary policy aggressively.

Markets have been worried China could over-tighten and slow
its economy too far.

Breaking the peg might mean China needs to buy less U.S.
dollars in intervention, which would leave it with fewer dollars
to buy U.S. Treasuries, but also less need to diversify its
holdings into currencies like the euro.
(Additional reporting by Gyles Beckford in Wellington; Editing
by Joseph Radford)

China said on Saturday it would gradually make the yuan’s exchange rate more flexible, indicating it was ready to break a 23-month-old U.S. dollar peg that had come under intense fire from abroad.

Investors were now waiting to see where Chinese authorities would actually set the yuan’s mid-point against the U.S. dollar later on Monday and to see how flexible the yuan becomes.

China’s central bank set the yuan’s daily mid-point at 6.8275 against the dollar on Friday.

The dollar recovered some of its earlier losses against the Australian dollar, euro and yen, as speculators cut short positions on the expectation that the yuan’s appreciation against the dollar would be a gradual one.

“We expect to see a visible move in the CNY/USD rate, but constrained by the 0.5 percent trading band,” said Scott Haslem, chief economist at UBS in Sydney.

The Aussie climbed more than 1 percent to a one-month high of $0.8830, before steadying around $0.8810, up from $0.8703 late in New York on Friday.

The New Zealand dollar also powered as much as 1.2 percent higher to a five-week high of $0.7140, before steadying around $0.7120, up 0.9 percent on the day.

The euro was trading up 0.4 percent at $1.2434, after being quoted as high as $1.2487. One trader said the euro did change hands for as much as $1.2490.

The yen eased 0.2 percent to 90.48, but off earlier low of 90.01 on trading platform EBS.

Most Asian currencies also gained, with the U.S. dollar dropping just over 1 percent against the Singapore dollar to a five-week low of 1.3697.

Westpac senior currency strategist Imre Speizer said for a variety of reasons the yuan statement was seen as positive for commodity currencies such as the Australian and New Zealand dollars, including the prospect of improved exports to China.

“This move may also have been designed to reduce friction at the G-20 meeting involving trade issues,” Speizer said.

The yuan’s value had been seen as a potential point of conflict at the Group of 20 summit in Toronto on June 26-27, as Washington pressed for moves to a market-based exchange rate, while Beijing had said the currency was its own business and outsiders should not meddle.

“Only a visible appreciation against the US dollar can quell international pressures and threat of trade protectionism,” said Scott Haslem at UBS in Sydney.

“However, we do not expect significant appreciation against the USD in the time ahead, particularly since the euro has weakened substantially.”

He saw the dollar reaching 6.55 yuan by year end, with this appreciation of between 3 and 4 percent likely achieved in the next few weeks.

A more flexible yuan would lessen the threat of a Sino-U.S. trade war, which could have been a danger to global growth, and enable China to buy more commodities, or at least cope better with higher commodity prices, a positive for big resource exporters like Australia and New Zealand.

A higher yuan would also help temper inflation in China by pushing down import prices, which in turn could mean Beijing would have less need to tighten monetary policy aggressively.

Markets have been worried China could over-tighten and slow its economy too far.

Breaking the peg might mean China needs to buy less U.S. dollars in intervention, which would leave it with fewer dollars to buy U.S. Treasuries, but also less need to diversify its holdings into currencies like the euro.

(Additional reporting by Gyles Beckford in Wellington; Editing by Edwina Gibbs)

The euro retained gains near $1.24 as investors liquidated
short positions after solid demand at Spanish bond auctions,
which also encouraged some investors to shift funds back to euro
zone bonds from safe-haven U.S. Treasuries, traders said.

Peripheral European debt markets calmed after the auction,
whetting investors’ appetite for riskier assets and supporting
higher-yielding currencies like the Australian AUD=D4 and New
Zealand dollars NZD=D4 which touched one-month highs.

“While the news flow out of Europe started the week negative,
a good Spanish bond auction overnight and the potential for a
coordinated bank stress test across the euro area … has
bolstered investor confidence that European officials are
beginning to get things right,” Barclays Capital said in a note
to clients.

The euro EUR= rose as far as $1.2414, a three-week peak,
and held at $1.2400 after gaining 0.6 percent on Thursday.

It has advanced more than 2 percent so far this week,
overcoming a Moody’s downgrade of Greece’s credit rating to junk
status and pulling further away from a four-year low of $1.1876
struck on June 7.

Traders said there were some light stops lined up above the
day’s high, with near-term resistance at $1.2457, the single
currency’s 2009 low hit during the global financial crisis.

The spread between Spanish government bond yields and
benchmark German Bunds narrowed from a euro lifetime high after
Thursday’s auction.

The euro was also being helped by broad dollar weakness after
a rise in jobless claims and weaker-than-expected manufacturing
data on Thursday prompted investors to scale back expectations of
a rate hike by the Federal Reserve. [ID:nN17254724]

“I still think the euro is a sell into rallies and I expect
it to see resistance at $1.25,” said Gregg Gibbs, currency
strategist at RBS, Sydney.

European leaders agreed on Thursday to publish details of
stress tests showing the financial health of individual banks
next month and to toughen budget rules to restore confidence in
their currency union. [ID:nLDE65G0TA]

Some market players believed the release of stress tests
would boost investor trust in European banks, but others were
concerned they could reveal fragility in the sector and hurt the
euro.

The dollar index .DXY was at 85.57, down 0.1 percent after
brushing a one-month low at 85.491. Technically it looked
vulnerable to a further fall after it broke through support at
85.85, with traders and analysts citing the 85.13 area — its May
21 low — after a bearish reversal in the previous session.

“If that level goes, then you’ll probably see a bit more
capitulation (from dollar longs) on that front,” said Sue Trinh,
senior currency strategist at Royal Bank of Canada in Hong Kong.

The dollar was marginally lower at 90.88 yen JPY=, having
fallen 0.5 percent in the previous session after the
weaker-than-expected U.S. data.

Trinh said there was some talk of stop-loss sell orders below
90.75 yen.

The Japanese government in its economic growth strategy
called on the Bank of Japan to “do its utmost” to beat deflation
and said fiscal and monetary policies for ending price falls
should help the country avoid excessive rises in the yen.
[ID:nTKU106089]

Analysts said the wording on the forex policy may have
sounded less aggressive than expected for some market players who
had expectations for drastic steps to weaken the yen, helping the
yen’s rise. But the overall reaction was limited, traders said.

The Swiss franc CHF= was also firm, having rallied after
Switzerland’s central bank backed off its pledge to fight
excessive currency strength now that deflation risks have
receded. For details, see [ID:nLDE65E1W2]

The dollar held at 1.1114 francs after revisiting a one-month
low of 1.1095. The euro was slightly lower EURCHF= at 1.3775
francs, not far from a record low of 1.3735 on EBS hit on June 9.

Meanwhile, the Australian dollar was up 0.2 percent at
$0.8693 AUD=D4, after touching a one-month high at $0.8714,
boosted by better risk appetite. The NZ dollar likewise was
holding just below a one-month high of $0.7068.
(Additional reporting by Anirban Nag in Sydney and Charlotte
Cooper in Tokyo; Editing by Joseph Radford)

The euro retained gains near $1.24 as investors liquidated short positions after a robust response to Spanish bond auctions, which also encouraged some investors to shift funds back to euro zone bonds from safe-haven U.S. Treasuries, traders said.

Peripheral European debt markets calmed after the auction, whetting investors’ appetite for riskier assets and supporting higher-yielding currencies like the Australian and New Zealand dollars which hovered near one-month highs.

“While the news flow out of Europe started the week negative, a good Spanish bond auction overnight and the potential for a coordinated bank stress test across the euro area … has bolstered investor confidence that European officials are beginning to get things right,” Barclays Capital said in a note to clients.

The euro was little changed at $1.2388, having gained 0.6 percent on Thursday, when it rose to as high as $1.2413 on trading platform EBS.

It has advanced more than 2 percent so far this week, overcoming a Moody’s downgrade of Greece’s credit rating to junk status and pulling away from a four-year low of $1.1876 struck on June 7.

Traders said there were some light stops lined up above $1.2413 with near-term resistance at $1.2457, the single currency’s 2009 low hit during the global financial crisis.

The spread between Spanish government bond yields and benchmark German Bunds narrowed from a euro lifetime high after Thursday’s auction.

The euro was also being helped by broad dollar weakness after a rise in jobless claims and weaker-than-expected manufacturing data on Thursday prompted investors to scale back expectations of a rate hike by the Federal Reserve.

“The euro is being helped by a short-covering rally, mainly due to some good news out of the Spanish bond auction and soft U.S. economic numbers,” said Gregg Gibbs, currency strategist at RBS, Sydney.

“But I still think the euro is a sell into rallies and I expect it to see resistance at $1.25.”

European leaders agreed on Thursday to publish details of stress tests showing the financial health of individual banks next month and to toughen budget rules to restore confidence in their currency union.

Some market players believed that the release of stress tests would boost investor trust in European banks, but many others were concerned they could reveal a fragile state of the European banking sector and hurt the euro.

The dollar index .DXY was at 85.632 and technically it was looking vulnerable to a further fall after it broke through support around the 85.85 area.

In the short term, the dollar index could fall to as low as 85.13 — the May 21 low — given the previous session’s bearish reversal.

The dollar was marginally lower at 90.88 yen, having fallen 0.5 percent in the previous session after the weaker-than-expected U.S. data.

The Japanese government in its economic growth strategy called on the Bank of Japan to “do its utmost” to beat deflation and said fiscal and monetary policies for ending price falls should help the country avoid excessive rises in the yen.

Analysts said the wording on the forex policy may have sounded less aggressive than expected for some market players who had expectations for drastic steps to weaken the yen, helping the yen’s rise. But the overall reaction was limited, traders said.

The Swiss franc was also firm, having rallied after Switzerland’s central bank backed off its pledge to fight excessive currency strength now that deflation risks have receded.

The dollar was at 1.1120 francs, not far from a one-month low of 1.1095 on EBS struck in the previous session. The euro was slightly lower on the franc at 1.3768, not far from a record low of 1.3735 on EBS hit on June 9.

Meanwhile, the Australian dollar was up 0.2 percent at $0.8693, a one-month high, boosted by better risk appetite. The NZ dollar likewise held just below a one-month high of $0.7064, at $0.7045.

(Additional reporting by Anirban Nag in Sydney; Editing by Chris Gallagher)

The Australian dollar pulled back further from a one-month
high versus the U.S. dollar as traders reduced demand for
higher-yielding currencies after minutes of an Australian central
bank meeting confirmed the market view that interest rates will
be on hold at least for the next month. [ID:nSYC002333]

Traders said with the euro EUR= failing to break near term
resistance at around $1.23, the single currency’s impressive run
in the past few sessions was showing signs of fizzling.

“The euro would need more than short-covering to move
decisively up from here,” said a senior trader at a Japanese
securities house, adding that the market still looked vulnerable
to euro-negative news given shaky equity markets.

The euro was at $1.2204 EUR=, down 0.1 percent from late
New York trade on Monday, retreating further from the previous
day’s high of $1.2298 on trading platform EBS.

Traders said Moody’s downgrade was being used by investors as
an excuse to pare positions in the single currency. Moody’s cut
Greece’s credit rating to junk status and said the country faced
substantial risks. [ID:nWNA3381].

The Moody’s downgrade could still have an affect in the
background, but an overall revival in risk appetite may check
sharp losses, traders said.

“We might get a bit of a negative reaction in Europe but it
was kind of already headed that way anyway with Greece, and the
more important thing to watch is the periphery countries like
Spain and Portugal,” said a senior trader at a European bank in
Hong Kong.

Resistance is still around a Fibonacci retracement level at
$1.2301, which is 23.6 percent of the euro’s move from an April
14 high to its June 7 low, and support is seen at around $1.2165
on hourly charts.

The euro fell as far as $1.1876 on June 7, its lowest since
March 2006.

“Whether the bounce in the euro from $1.19 to $1.22 is more
than a brief relief bounce remains open for debate but the sharp
reaction to the rating downgrade overnight suggests that
sentiment is still extremely fragile,” Matthew Strauss, senior
currency strategist at RBC Capital wrote in a note.

The euro fell 0.2 percent on the yen EURJPY= to 111.70 yen.
The U.S. dollar edged down to 91.50 yen JPY= as sell orders
from Japanese exporters were seen capping its gains.

In the options market, the recent rebound in euro/yen and
Aussie/yen was reducing the attraction of yen calls and prompting
traders to dump options since euro/yen failed to break below a
barrier at 108 yen last week.

Implied volatilities on short-end dollar/yen options have
fallen, with one-month vol hitting a one-month low below 11.5
percent JPYVOL, extending a decline in the past week.

The Bank of Japan detailed a new loan scheme after its policy
meeting, saying it would lend up to $33 billion to commercial
banks to help redirect money to industries with growth potential,
but analysts doubt its effectiveness when loan demand is low.
[ID:nTOE65D05B] [ID:nTOE65E03M]

The minutes of the Reserve Bank of Australia’s June policy
meeting said it was able to leave interest rates unchanged in the
near term as previous rate hikes gave it time to see how Europe’s
debt woes would affect the world economy and to wait for more
information on domestic inflation.

Board members also said disinflationary forces in the
domestic economy had not been as strong as expected and
highlighted the importance of coming data on consumer prices, due
in late July, reinforcing expectations for steady interest rates
at its next policy-setting meeting in early July.

The Australian dollar AUD=D4 fell 0.2 percent to $0.8564,
extending its pullback from a one-month high of $0.8665 the
previous day when an overall improvement in risk appetite
supported demand for higher-yielding currencies.
(Additional reporting by Anirban Nag in Sydney and Hideyuki
Sano and Charlotte Cooper in Tokyo; Editing by Joseph Radford)

The outstanding volume of CDS written on JGBs has doubled in the past eight months as Europe’s sovereign debt crisis has made anxious banks and investors hedge their exposure to Japan, the most heavily indebted of the major economies.

Japan’s public debt — totalling nearly 200 percent of GDP — has long been financed domestically from the country’s massive pool of savings that mostly sits in the banking system and is recycled into JGBs.

But fears are growing that the ageing population will start drawing on that pool of savings, forcing Japan to rely on foreign investors to fund its debt and potentially creating market instability.

New Prime Minister Naoto Kan, who has vowed to start fixing the tattered finances, warned on Friday Japan risked default if it failed to act, and investors are not convinced it has been taking enough steps to head off a crisis down the road.

Graphic on CDS spread/volume, click link.reuters.com/xag59k

While other sovereign CDS spreads have shrunk this week along with a rebound in stock markets, Japanese sovereign CDS spreads have edged out to 99 basis points, pushing back towards a record peak of 130 basis points and up from 3 basis points just three years ago.

Some analysts are wary the big increase in volume on Japanese sovereign CDS may spark a volatile widening of spreads that could even prompt domestic investors to start shedding their JGB holdings.

“Fear is what drives CDS, big upticks take place when sentiment is weak. It is a game of increasing fear as much as possible and then getting out,” said a senior credit trader at a U.S. bank.

Foreign commercial banks, which have loan business with Japanese companies and swap houses exposed to yen products, are among the buyers of protection, traders said.

“There are participants out there scared enough to buy protection. People really drive hard on fear. It is ‘hedge when you can, not when you have to’.”

CDS VOLUME INCREASE

Net notional volume of Japan’s five-year sovereign CDS stood at $4.45 billion on June 4, data from the Depository Trust & Clearing Corporation (DTCC) shows, up from $2.94 billion at the end of November.

Traders said some investors have made handsome profits over the past two years thanks to extreme moves in CDS, which is the best scenario for dealers.

The Japanese government is doing little to give a sense of security to the markets in managing its public debt, and this could be used by speculators to create market volatility and opportunity for profits, the trader at a U.S. bank said.

Potential disappointment or a downgrade of the sovereign credit rating following Japan’s expected medium-term outlook on fiscal restructuring due later in the month could be their trading incentives.

Volume has also grown in U.S. sovereign CDS and UK sovereign CDS in the past year, a research paper released by the Bank of Japan in April showed, reflecting market concerns over the fiscal state of major economies after a blow-up in government spending following the global credit crisis.

But the volume in Japan sovereign CDS remained about 1 percent of a total of $2.17 trillion, in which Italy’s sovereign CDS had the biggest share at 10 percent.

Traders said the biggest advantage of CDS was its low cost enabling speculators to make bets. Protection against Japan’s default risk was bought and sold almost entirely by overseas investors, they said.

For that reason, some analysts warned that price movements in Japan sovereign CDS may become very volatile and that in turn could sour sentiment among domestic investors towards JGBs, resulting in higher costs for Japan to finance its debt.

“A boost in trading activity may come sooner than we’re now anticipating if more foreign players recognise the trend of falling domestic savings and an expected rise in foreign JGB holdings in the coming years, and find motivation to sell protection now,” said Jun Ishii, chief fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities, in a client note in April.

DOMESTIC INVESTORS MAY BE MORE PIVOTAL

Market experts argue that Japan’s sovereign CDS market, despite the recent jump in volume, is still a drop in the bucket compared to the huge JGB market dominated by real money domestic investors who invest trillions of yen.

It will be the domestic investors, not overseas players, who would rock the JGB market if they decide to react negatively on fiscal concerns, they say.

Japan’s five-year CDS spread rose to a 14-month high of 98 basis points in late May as fears escalated that the euro zone’s debt crisis was spreading to its banking system.

That was a day after the benchmark 10-year JGB yield dropped to a five-month low of 1.190 percent .

“A sort of correlation between CDS spreads and JGB yields may exist but when you are talking about a hundred million on one side and a trillion on the other, it is like smoke and mirrors. I am skeptical that the CDS market can move JGBs,” said the trader at a U.S. bank.

(Editing by Eric Burroughs)

(For more business news on Reuters India click in.reuters.com)

A stronger-than-expected rise in Australian employment
numbers for May and a near 50 percent surge in Chinese exports
the same month ran counter to persistent fears the global economy
was starting to falter amid euro zone debt woes.

Dai Xianglong, chairman of $114 billion China’s National
Social Security Fund, said the euro would gradually stabilise and
that the U.S. fiscal deficit remained a big concern.
[ID:nTOE659041]

The euro rose 0.7 percent on the day to around $1.2059
EUR=EBS and at one point climbed as high as $1.2064, up more
than one U.S. cent from an earlier low of $1.1957.

It has risen about 1.5 percent since hitting a four-year low
of $1.1876 on trading platform EBS on Monday.

“Traders are buying back the euro for now but there aren’t
strong factors to support the euro. I expect the euro will meet
solid resistance near $1.22,” said Koji Fukaya, a senior currency
analyst at Deutsche Bank in Tokyo.

Traders expect the euro to come under pressure again after
short-covering runs its course, with many market players looking
to see if the European Central Bank, which meets later in the
day, plans new efforts to help troubled euro zone countries.

The ECB is expected to keep interest rates at a record low
when it meets on Thursday. [ID:nLDE6521S4]

Against the yen, the euro rose 0.5 percent to 109.85 yen
EURJPY=R and the dollar was little changed at 91.20 yen JPY=.

The Australian dollar rallied as much as 1.5 percent at one
point after Australia added 26,900 jobs in May, much more than an
expected 17,500. It later changed hands at $0.8365 AUD=D4, up
about 1.2 percent on the day.

Data also showed full-time jobs again blew away forecasts
with a big 36,400 jump and the jobless rate also surprised by
dipping to 5.2 percent. That suggests wage pressures could begin
to build and that there was more risk of further increases in
interest rates than currently priced by markets.[ID:nSGE658092]

The Aussie added to its gains after China confirmed faster
exports. China’s exports rose 48.5 percent in May from a year
earlier and imports were up 48.3 percent.[ID:nTOE65605K]

“The data from Australia and China, together with remarks
from (Fed Chairman) Bernanke yesterday on the U.S. economy,
suggest that the European debt problems have so far not been
damaging economies elsewhere,” said Minoru Shioiri, chief manager
of forex trading at Mitsubishi UFJ Morgan Stanley Securities.

“But recent heavy price movements in stock markets indicate
it’s hard to expect a full recovery of sentiment in the financial
markets soon,” Shioiri said.

The New Zealand dollar climbed after the country’s central
bank sounded slightly more positive than expected in its policy
statement. It raised interest rates for the first time since the
global crisis, as widely expected, and investors looked for more
rate rises in coming months. [ID:nSGE65701N][nWEL004070]

The New Zealand dollar was up 1 percent at $0.6786 NZD=D4.
(Additional reporting by Hideyuki Sano; Editing by Edwina Gibbs)