Yen Slumps as S&P Downgrades Japanese Credit Rating; Aussie Dollar Drops

The yen declined after Japan’s credit rating was lowered one step to AA- by Standard & Poor’s, the first cut since 2002, on concern Prime Minister Naoto Kan hasn’t done enough to curb the world’s biggest debt load.

The Japanese currency was lower against all of its 16 most- traded peers, declining for the first day in five against the dollar. The euro strengthened against the dollar for the fifth- straight day as European Central Bank Executive Board member Lorenzo Bini Smaghi said imported inflation can’t be ignored. The Australian dollar fell after Prime Minister Julia Gillard announced a one-off levy to fund rebuilding after recent floods, damping demand for the South Pacific nation’s assets.

“News of Japan’s rating downgrade spurred yen selling as it occurred,” said Koji Fukaya, chief currency strategist in Tokyo at Credit Suisse Group AG. “With domestic investors holding most of Japanese government bonds, the direct impact on the currency market will likely be small. Still, in the near term, the market will likely take this as a negative.”

The yen weakened 0.8 percent to 82.84 per dollar as of 6:26 a.m. in New York, after dropping as much as 1.3 percent. Japan’s currency depreciated 1 percent to 113.7 per euro.

“The downgrade reflects our appraisal that Japan’s government debt ratios -- already among the highest for rated sovereigns -- will continue to rise further than we envisaged before the global economic recession hit the country,” S&P said in a statement today. “In our opinion, the Democratic Party of Japan-led government lacks a coherent strategy” to address the nation’s debt problem, the statement said.

‘Temporary Effect’

“It will only have a temporary effect on the market,” said Lee Hardman, a strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. in London. “Japan’s credit rating has been on negative watch for almost a year now so this is something which has been on the cards for some time.”

Standard & Poor’s move underscores concern that policy makers may struggle to finance public debt that Japan’s Finance Ministry said will probably swell to 997.7 trillion yen in the year starting April 1, or about twice the size of gross domestic product. The Finance Ministry yesterday estimated the nation’s bond sales may surpass 50 trillion yen in the year starting April 2013, an indication Kan won’t be able to meet his pledge of keeping new bond sales at 44.3 trillion yen.

“The effect will be ephemeral and it will peter out,” David Bloom, global head of currency strategy at HSBC Holdings Plc in London, said today by phone. “I don’t think you’re going to be frightening the locals. That’s the difference between Japan and the rest of the world.”

Dollar Decline

The Dollar Index, which tracks the greenback against the currencies of six major U.S. trading partners including the yen, weakened 0.2 percent to trade at 77.738, its fifth-straight day of declines. Immediately after Japan’s cut it gained 0.3 percent to 78.147. The pound traded little changed at $1.5944 after depreciating 0.3 percent.

Japan now has the same credit rating as China at S&P, highlighting the rise of a Chinese economy that likely overtook its Asian neighbor in size last year. Japan’s economy is forecast to expand at half the rate of the U.S. economy this year, according to the median estimate of 13 economists surveyed by Bloomberg. The nation is also set for its third-straight year of deflation, Bloomberg data shows.

The euro rose 0.1 percent to $1.3726, reversing a decline of as much as 0.6 percent earlier as French President Nicolas Sarkozy said European leaders would continue defending the currency union.

‘Cataclysmic Event’

“It is of such importance that we will be there whenever it needs to be defended,” Sarkozy said of the euro in a speech at the World Economic Forum in Davos, Switzerland. “The consequences of a euro failure would be so cataclysmic that we can’t even entertain the idea.”

The European Central Bank this month stepped up its inflation-fighting rhetoric after the annual rate of consumer- price gains in the euro area breached its 2 percent limit for the first time in more than two years.

“A permanent and repeated increase in the prices of imported products will tend to impact on inflation in the advanced countries, including the euro area,” Bini Smaghi said in a speech in Bologna, Italy, today. “This phenomenon can no longer be ignored.”

The Australian dollar weakened against 15 of its 16 major peers after Gillard said the nation’s worst flooding will cost an estimated A$5.6 billion ($5.58 billion) and shave around 0.5 percentage point off gross domestic product growth.

Australian Flood

“The market was pricing in some kind of fiscal stimulus to help clear up the floods, which would be Aussie positive, now they’ve come out and imposed this tax, which is Aussie dollar negative,” said Chris Walker, a foreign-exchange strategist at UBS AG in London. “We continue to sell because the data is trending to the downside and you have the added effect of this tax on top of the negative fundamental effect of the floods themselves.”

Gillard’s government plans a one-off tax to raise about A$1.8 billion to help pay for reconstruction. Australia’s currency dropped 0.8 percent to 99.18 U.S. cents.

To contact the reporters on this story: Emma Charlton in London at echarlton1@bloomberg.net

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net

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