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Yen Rises as European Stress Tests, Slowdown Concerns Boost Safety Demand

The yen rose, snapping a two-day decline against the dollar and the euro, as concern over the pace of the U.S. recovery and the financial health of European banks boosted demand for Japan’s currency as a refuge.

The yen climbed against all of its 16 major counterparties. Federal Reserve Chairman Ben S. Bernanke speaks today on the economy. Reports tomorrow may show initial jobless claims increased and existing home sales fell, according to surveys of economists by Bloomberg. The euro weakened against 15 of its 16 most actively traded counterparts.

“The yen benefits in times of risk aversion, and Bernanke has to tread a very fine line,” said Neil Mellor, a currency strategist at Bank of New York Mellon Corp. in London. “He has to be frank about downside risks, while reassuring that the economic recovery is intact. The European bank stress tests add to the uncertain backdrop.”

The yen appreciated to 111.37 per euro at 7:04 a.m. in New York, from 112.70 yesterday. The currency gained to 87.02 per dollar, from 87.51, after advancing to 86.27 on July 16, the strongest level since Dec. 1. The dollar traded at $1.2794 per euro, from $1.2880. The euro reached $1.3029 yesterday, its strongest level since May 10.

“The euro’s failure to sustain a breach of $1.30 has prompted some selling ahead of the major risk event posed by Bernanke’s testimony,” Mellor said.

Bernanke delivers his semiannual report on monetary policy to the Senate Banking Committee today, and testifies to the House Financial Services Committee tomorrow. U.S. policy makers trimmed growth forecasts for this year and next at the Federal Open Market Committee’s June meeting, according to minutes released July 14.

‘Undermine the Dollar’

There is speculation the Fed may announce fresh stimulus measures, such as cutting the interest paid on excess reserves, Mitul Kotecha, Hong Kong-based global head of foreign-exchange strategy at Credit Agricole Corporate & Investment Bank, wrote today in a note.

“The downgrades to the Fed’s growth forecasts and recent relatively dovish FOMC minutes have helped to fuel such speculation, which if in any way confirmed by Bernanke, will act to undermine the dollar further,” he wrote.

Initial jobless claims rose to 445,000 last week from 429,000 in the prior period, according to a Bloomberg survey before tomorrow’s Labor Department report. The same day, the National Association of Realtors will say sales of existing homes fell 9.9 percent in June, according to a separate survey.

Rate Futures

“Disappointing economic data and diminishing expectations the Federal Reserve will raise rates have pushed down the dollar,” said Satoru Ogasawara, a foreign-exchange analyst and economist in Tokyo at Credit Suisse Group AG. “The dollar may fall to 85 yen in the short term.”

The extra yield offered by U.S. swap rates over their Japanese counterparts has shrunk to near a two-decade low, fueling the yen’s rally toward the strongest against the dollar since 1995.

The premium U.S. rates offer to same-maturity instruments in Japan dropped to as little as 38 basis points last week amid fading expectations that the Federal Reserve will raise interest rates, said Tohru Sasaki, chief strategist in Tokyo at JPMorgan Chase & Co. Swap rates are fixed payments made to receive floating rates.

The dollar-yen rate “has been closely tracking” the two- year swaps gap, said Sasaki, a former chief currency trader at the Bank of Japan. The exchange rate “in the near future” may reach the 84.83 yen level touched on Nov. 27, the strongest for the Japanese currency since July 1995, he said.

Futures Outlook

“The view that there will be no rate hike in the foreseeable future is strengthening,” Sasaki said. Traders “are scaling back expectations for rate increases in the U.S., broadening declines in swap rates from three- and six-month instruments to two-year ones.”

Futures on the Chicago Mercantile Exchange show a 48 percent chance the Fed will keep its benchmark rate between zero and 0.25 percent through its March 2011 meeting, up from 43 percent odds a month earlier.

European regulators plan to detail three scenarios when they publish their stress-test results for 91 of the region’s lenders on July 23, according to a document by the Committee of European Banking Supervisors.

Banks will publish their estimated Tier 1 capital ratios under a benchmark for 2011, an adverse scenario and a third test that includes “sovereign shock,” according to a template prepared by CEBS for the banks and obtained by Bloomberg News.

‘Unlikely to Overwhelm’

The euro may fall as low as $1.2750 as trading thins before the publication of the stress test results, Lloyds Banking Group Plc said.

“Commitment is unlikely to overwhelm as volumes recede ahead of Friday’s stress test results,” Kenneth Broux, a senior market economist at Lloyds in London, wrote in a note today. “We are not huge fans of euro-dollar rally over $1.30 and target a return to the area around $1.2750.”

The euro has declined 8.3 percent this year, the biggest loss among its developed-world counterparts, according to Bloomberg Correlation-Weighted Indexes. The dollar has gained 3.9 percent, and the yen has advanced 11.9 percent.

Australia’s dollar fell versus the yen on speculation a slowing global economy will prompt the nation’s central bank to keep interest rates unchanged next month.

The statistics bureau will release inflation data on July 28. Consumer prices rose 2.9 percent in the first quarter from a year earlier, the most since late 2008, data showed in April. The Reserve Bank of Australia meets on Aug. 3.

Australian Dollar

“Until CPI comes out, it’s difficult to see where the market’s going to get the next thrust in terms of pushing higher yields in the money market and therefore the Aussie dollar,” said Michael Katz, a currency fund manager at Tallship Investments in Sydney. “The odds are the RBA won’t be hiking in August, and the idea of the Aussie going back into the 90s would require a rate hike.”

Australia’s dollar declined 0.6 percent to 76.91 yen.

To contact the reporters on this story: Keith Jenkins in London at kjenkins3@bloomberg.net; Yoshiaki Nohara in Tokyo at ynohara1@bloomberg.net

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