Yen gains in choppy trading, euro on defensive

[December 15, 2014]  By Jamie McGeever and Patrick Graham
 
 LONDON (Reuters - The yen inched higher on Monday as financial markets shrugged off Japanese Prime Minister Shinzo Abe's election win, while the prospect of falling European inflation kept the euro on the defensive.

Japan's Nikkei stock average <.N225> fell 1.6 percent. Many investors, particularly foreigners, sell the yen to hedge equities positions, so the Japanese currency tends to feel upward pressure whenever stocks slip.

But a victory for Abe's coalition in Sunday's general election was a boost for his reflationary economic policies, which are likely to weigh on the yen in the long term.

"The market was expecting this (Abe's victory) to support stocks and dollar/yen ... However, it seems like this is more of an early morning shakeout," said Josh O'Byrne, G10 currency strategist at Citi in London.

The yen handed back some of its gains in morning trade in Europe but was still 0.1 percent higher on the day against the dollar at 118.75 <JPY=EBS>

The euro fell against both the dollar and yen after European Central Bank policymaker Ewald Nowotny said euro zone inflation would fall further in the first quarter. The Bundesbank said plunging oil prices meant it would probably need to cut its forecasts for inflation and the ECB's favored measure of inflation expectations fell further.

That all strengthened the growing conviction that the ECB will have to start outright purchases of government bonds in the first quarter to raise the number of euros in circulation.

"It is a messy pre-Christmas market but the euro still looks weak. All of these policy messages are in there," said one London-based dealer. He also said there had been hedge fund sales of sterling, down a third of percent at $1.5665.

A 40 percent fall in oil prices this year is reverberating across a number of emerging and developed economies. Norway's crown sank to a six-year low of 9.2130 crowns. <EURNOK=>

The drop <LCOc1> <CLc1> also makes it harder for the ECB to lift inflation - currently 0.3 percent - back to its target of just below 2 percent. Five-year/five-year forwards, the ECB's preferred measure of inflation expectations, fell to a new low of 1.69 percent.

The main focus for currency markets this week will be the Federal Reserve's last policy meeting of 2014, ending on Wednesday. Fed chief Janet Yellen is expected to avoid any sign interest rates will rise too soon. The U.S. economy may be doing relatively well, but weakness in the euro zone, Japan and China adds to the risk of a U.S. slowdown.

"There's a focus on the Fed – the market is thinking about oil, but the medium term will be more dependent on monetary policy and not market volatility. Into year-end though, there is some incentive to close positions and perhaps there is a shorter threshold for pain," Citi's O'Byrne said.

(Additional reporting by Tomo Uetake in Tokyo and Ian Chua in Sydney; Editing by Tom Heneghan and John Stonestreet)

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