ANZ's Eslake Says Australian Dollar-Yen May Fall on Subprime

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By Stanley White

Sept. 6 (Bloomberg) -- The Australian dollar may slump 13 percent against the yen in two years as U.S. subprime mortgage defaults encourage investors to cut holdings of the currency bought with borrowed money in Japan, said Saul Eslake, at Australia & New Zealand Banking Group Ltd.

"We expect the Australian dollar to be under pressure against the yen,'' Eslake, ANZ's chief economist, said at a client seminar in Tokyo yesterday. "There's more bad news to come because so many banks are exposed to subprime loans. We are seeing a re-pricing of risk, and risk aversion looks somewhat permanent.''

The Australian dollar has slid 10 percent against the yen since Bear Stearns Cos. said June 22 it would bail out one of its hedge funds that lost money on loans to U.S. homeowners with poor credit. IKB Deutsche Industriebank AG and Bank of China Ltd. are among banks to say they're also likely to lose money on U.S. subprime mortgages, prompting investors to shun purchases of higher-yielding assets funded with borrowed yen.

Demand for so-called carry trades pushed Australia's dollar to a 16-year high against the yen in July, making the nation's exports more expensive in Japan, its largest overseas market. A government report this week showed Australia's economy expanded at a slower pace in the second quarter from the previous three months as a stronger currency crimped exports.

Currency Forecast

The Australian dollar traded at 94.37 yen at 9:31 a.m. in Tokyo from 95.11 late yesterday in Asia. It will extend its drop to 82 yen at the end of 2009, according to Melbourne-based Eslake. That would be the lowest since June 2005.

In a carry trade, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the borrowing and lending rate. The risk is that currency market moves erase those profits. Japan's benchmark rate is the lowest in the industrialized world at 0.5 percent. The Reserve Bank of Australia yesterday kept its policy rate unchanged at an 11-year high of 6.5 percent.

The Federal Reserve will lower its benchmark interest rate of 5.25 percent at least once this year to prevent the housing market from weighing on the world's largest economy, Eslake said. The Fed cut the discount rate it charges banks for loans by 50 basis points to 5.75 percent on Aug. 17.

Commercial Paper

Lower interest rates may not restore confidence in the U.S. financial system as banks are reluctant to lend on speculation losses on subprime loans are spreading, Eslake said.

Yields on top rated U.S. asset-backed commercial paper with 30-day maturities have risen 22 basis points in the past two weeks to a six-year high of 6.26 percent, according to data compiled by Bloomberg. Investors are avoiding making short-term loans to funds that might hold subprime mortgages.

Outstanding asset-backed paper, which accounts for about half the commercial paper market, has declined by $184.9 billion, or 16 percent, in the three weeks ended Aug. 29, as investors fled to the safety of Treasuries.

"There's been little success in reviving the commercial paper market,'' Eslake said. "Until this is corrected, this poses a risk to economic activity.''

The Australian dollar may fall 12 percent against the U.S. currency to 73 U.S. cents at the end of 2009 as commodity prices have peaked and will start to decline slowly, Eslake said. The currency of the world's 15th largest economy fetched 82.06 U.S. cents from 82.25 yesterday in Asia.

Commodity Currency

The Australian dollar is typically linked to the price of raw materials as coal, iron ore, nickel and other resources make up about 60 percent of Australian exports, contributing about 14 percent to the nation's growth.

The Reuters/Jefferies CRB Commodity Price index has fallen 4.9 percent since reaching the highest in almost a year on July 20, due to speculation global financial market losses will slow economic growth and cut demand for raw materials.

Australia's record current account deficit of A$16 billion ($13 billion) in the second quarter also means its currency is likely to weaken longer term, Eslake said.

When a country runs a deficit in its current account, the broadest measure of trade, it relies on excess savings from other countries to fund its own savings shortfall. A weaker currency would make it easier for overseas investors to fund Australia's current account deficit, Eslake said.

To contact the reporter on this story: Stanley White in Tokyo at swhite28@bloomberg.net

Last Updated: September 5, 2007 20:43 EDT