The yen's broad rally gathered steam on Friday as continued turmoil in global financial markets caused investors to shun risk, cutting their exposure to carry trade positions. High-yielding currencies including the Australian and New Zealand dollars fell sharply as steep declines in global equities further soured investors' risk appetite - already dented by concern over a liquidity and financing squeeze.
Short term US dollar deposit rates on Friday surged above 6 percent - well above the Federal Reserve's 5.25 percent Fed funds target rate - as banks scrambled for cash amid deepening worries about credit market losses, which punched equities down and spurred a rush to unwind risky carry trades.
Jitters deepened on Thursday after France's biggest listed bank, BNP Paribas, froze 1.6 billion euros ($2.19 billion) worth of funds, citing trouble with the US subprime mortgage sector.
The subsequent jump in eurozone overnight borrowing rates forced the European Central Bank to inject nearly 100 billion euros of funds into the banking system. It acted again on Friday, injecting 61.05 billion euros into the eurozone money markets, for a net drain of 33.791 billion euros in cash.
"There's only one show in town at the moment and that's what credit markets are doing, it looks like it's going to continue for now at least," Westpac currency strategist Geoff Kendrick said.
"The new thing is also that next week you will hear hedge fund profit and loss figures for July - so the market is quite nervous ahead of that as well," he added.
At 1223 GMT, the dollar was down 0.5 percent from late US trade at 117.49 yen, heading back towards the four-month low of 117.16 yen hit according to Reuters earlier this week. The Aussie fell 1 percent to 99.21 yen, while the kiwi dropped 1.6 percent to 87.15 yen a three-month low.
The euro was down 0.6 percent at 160.55 yen, having hit its lowest since mid-April at 160 yen earlier, and was flat against the dollar at $1.3674. "There are still some pronounced risks - if there was a deeper liquidation of positions, the yen could strengthen further," BTM UFJ currency economist Derek Halpenny said.
Yen volatilities hit multi-year highs - one-month implied dollar/yen flirted with 11 percent earlier, their highest in a year, while one-week vols hit 13.6 percent, their highest in over 3 years.
The ECB's record-setting liquidity injection on Thursday was followed by similar but much smaller operations by the Fed, Bank of Canada, Bank of Japan and the Reserve Bank of Australia. Analysts said these operations, the ECB's aside, didn't amount to emergency action.
"It's a tough one for the Fed, they know that if they inject too much liquidity the market will think they are going to cut rates. They only want to play that game if they are really worried," Westpac's Kendrick said. The broader fear is that financial market volatility eventually filters through to the macroeconomic environment.
"While the bad news from the US subprime and related markets continues this volatility is likely to go on," Standard Chartered analysts wrote in a note to clients on Friday. Rates futures markets slashed bets on how high the ECB will lift rates. September Euribors are now pricing only a 50-50 probability of rates rising next month, compared with around a 70 percent likelihood on Thursday.
The August fed funds futures contract showed traders betting on a 33 percent chance of a rate cut this month, and the September contract was discounting a 75 percent chance of policy easing by the end of September. The tumult in global financial markets has also stirred doubts about whether the Bank of Japan will raise interest rates later this month.
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