Feb. 21 (Bloomberg) -- The Australian and New Zealand dollars will surge to almost 10-year highs against the yen within a month as traders continue to borrow in Japan to buy the nations' higher-yielding assets, RBC Capital Markets said.

The Australian and New Zealand currencies strengthened against the yen today as the Bank of Japan said borrowing costs will stay low after pushing the interest rate up by a quarter- percentage point to 0.5 percent. This will encourage investors to keep putting on so-called carry trades whereby they borrow cheaply in Japan and buy Australian and New Zealand bonds, currency strategists at RBC wrote in a report.

``The yen is, and will remain, a cheap funding currency for buying Australian and New Zealand dollars for non-Japanese investors,'' Monica Fan, global head of foreign exchange strategy in London, and her colleagues wrote. ``We expect the Australian and New Zealand dollars to rally over the next months as yen- funded carry trades are re-established.''

The Australian dollar, trading at 95.47 yen at 1:20 p.m. in London, will climb to 97.17 yen in the next month, RBC forecast. That would be the strongest since May 1997.

The New Zealand dollar, buying 85.26 yen, will appreciate to 87.33 in one month, the bank predicted, also the highest exchange rate since May 1997.

Governor Toshihiko Fukui and his policy board colleagues voted 8-1 to increase the overnight lending rate from 0.25 percent, the second increase in eight months. Japan's rates are still the lowest among major economies.

After the decision the yen fell against the 16 most active currencies, posting its worst performance versus the Australian and New Zealand dollars.

Widening Rate Gap

Australia's overnight cash rate target is at a six-year high of 6.25 percent, 5.75 percentage points higher than Japan's, while New Zealand's benchmark at 7.25 percent is 6.75 percentage points more.

RBC said in the report the Australian and New Zealand dollars would benefit from the carry trade as investors speculated rates would go higher still in the two countries.

Reserve Bank of Australia Governor Glenn Stevens said today it is ``too soon to declare victory'' on inflation and the bank is more likely to raise interest rates than cut them.

The Asia-Pacific region's fifth-largest economy is in its 16th year of expansion and the jobless rate has dropped to a 31- year low, putting pressure on companies to pay more to attract workers and spurring inflation.

The Reserve Bank of New Zealand Governor Alan Bollard will raise its benchmark rate to 7.5 percent on March 8, according to 13 of 14 economists surveyed by Bloomberg News.

`Strengthen Further'

``Until Australian and New Zealand interest rates have definitely peaked we expect the Australian and New Zealand dollars to strengthen further,'' the RBC strategists wrote in the report, which Fan confirmed by phone.

The two currencies will also be underpinned by demand from Japanese individual investors for the higher yields offered by the nation's bonds, RBC said.

Australia's two-year government bonds yield 5.19 percentage points more than similar-maturity Japanese notes. The yield spread on New Zealand three-year bonds was 5.93 percentage points.

``Yield-hungry Japanese retail investors are less sensitive to currency fluctuations,'' the report said. ``The appeal of buying foreign bonds, especially Australian and New Zealand denominated bonds, has increased.''

RBC is a unit of the Royal Bank of Canada, the country's largest bank by assets.

To contact the reporter on this story: Chris Young in London at cyoung12@bloomberg.net

Last Updated: February 21, 2007 08:51 EST