G7 reserves stabilising as BoJ offsets Fed
Simon Ward
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A previous post suggested that a further rise in US bank reserves implied by the Fed completing QE2 would be offset by a fall in Japanese reserves, as the temporary boost from foreign exchange intervention and emergency lending to the banking system unwound. The surge in G7 reserves since early February – a contributor to recent strength in "risk assets" – might, therefore, end before QE2 itself. The Bank of Japan's liquidity withdrawal, meanwhile, might support the yen.
This scenario seems to be playing out. Japanese bank reserves have fallen by ¥6.0 trillion, or $81 billion, from a peak in late March versus a $95 billion rise in the US from the same date (as of last week) – see chart. The yen's effective exchange rate has rallied since early April, though partly in reflection of generalised US dollar weakness.
Hopes that the Great Hanshin earthquake would force the Bank of Japan to embark on massive Fed-style QE have been disappointed. A proposal to increase the "asset purchase program" (dominated by collateralised lending to the banking system rather than direct securities purchases) by a modest ¥5 trillion was defeated by eight votes to one at today's policy board meeting. Japanese reserves may decline further as the sterilisation of last month's intervention continues and banks' demand for funds normalises.
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