The dollar held its own on Tuesday, as investors waited to see if Japan's leader would call a snap election after the country unexpectedly slipped into recession and European Central Bank officials raised the prospects of further stimulus steps. The dollar was steady on the day at 116.63 yen, within sight of its seven-year peak of 117.06 yen touched on the EBS trading platform on Monday after Japan's downbeat gross domestic product data.
Japan's economy contracted an annualised 1.6 percent in July-September, after plunging 7.3 percent in the second quarter following a rise in the national sales tax, which hit consumer spending hard. The technical recession sets the stage for Prime Minister Shinzo Abe to delay an unpopular further hike to the sales tax and call a snap election, likely on December 14. He was expected to announce his decision at a news conference later on Tuesday after his economic advisers meet, media and ruling party lawmakers have said.
"We need to focus on the possible supplementary budget, and not just the delay of the sales tax increase," said Masashi Murata, senior currency strategist at Brown Brothers Harriman in Tokyo. Japan's surprise recession added to expectations that the Bank of Japan will continue its monetary easing for a while, and underscored the sharp divergence with policy expectations for the United States.
The Federal Reserve could raise interest rates in mid-2015 if the US economy continues apace, but monetary accommodation is needed for now because inflation "is likely to remain weak for some time," Fed Governor Jerome Powell said on CNBC television on Monday. "Powell said the Fed is likely to hike in the middle of next year, which is good news for dollar-bullish people, and also good to make the market more stable," by giving a hint on the timing of a possible move, Murata said.
Barclays strategists tweaked its dollar-yen forecasts and now expect the pair to stand at 120 in six months and 117 in one year, compared with previous estimates of 112 in both the six-month and one-year horizons. The revision was made "to reflect the deterioration in Japan's inflation outlook and the Bank of Japan's response to that outlook," they said.
Meanwhile, ECB President Mario Draghi said on Monday that the central bank was ready to take more steps to support the euro zone's recovery. Earlier in the day, ECB Executive Board member Yves Mersch detailed what such steps might include, and said the ECB could theoretically buy gold, shares, exchange traded funds (ETFs) or other assets if needed.
The euro edged up on the day to $1.2475 but remained below a more than two-week peak of $1.2580 hit overnight. The dollar index, which measures the greenback against a basket of major currencies, edged down to 87.808, but was not far from a four-year high of 88.267 set on Friday.
The Australian dollar edged up on the greenback to $0.8721, as the outlook for sustained monetary policy support from the ECB and Bank of Japan favoured carry trades, in which investors borrow in economies with low rates and use the proceeds to buy financial assets where rates are higher. But the Reserve Bank of Australia will not welcome a surge in capital inflows. The central bank repeated in the minutes of its November policy meeting that the Aussie dollar remained above most estimates of its fundamental value.
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