G7 will not allow forex credibility to be questioned

The Group of Seven nations do not put their credibility on the line lightly. Those tempted to question whether their first co-ordinated intervention in the currency markets in a decade will be successful should be mindful how much is at stake and the G7 nations' successful track record of getting their own way.
This is not the primary concern of corporates and hedge funds, whose yen purchases are currently diluting the impact of the yen slide that the G7 engineered with Friday's intervention after speaking out the previous day against "excess volatility and disorderly movements in exchange rates".
But the G7 has never thrown down the gauntlet to the foreign exchange market in recent decades without following it up - for days, weeks, and months if necessary - with action that has stabilised currencies and eventually reversed trends. "We are one minute into a 90-minute game. Intervention is a long game and the central banks will win this," said Gavin Friend, strategist at National Australia Bank in London.
"Speculators can take them on but they won't win. The yen will not be allowed to go back up and eventually the market will recognise this even if it is being a bit slow to catch on right now. The G7 countries are using their own money and this should eventually convince the market they mean business." The case for co-ordinated intervention was strengthened by the scale of the yen's rise on Thursday and the signals from the derivatives market, where implied yen volatilities soared.
Given the relative calm in the bond and equity markets at the time, joint intervention could be more easily justified as directed at calming "disorderly" moves that were specific to the currency markets. Nothing the G7 nations have said or done so far suggests they are trying to weaken the yen to any particular level.
But now they have shown their hand, they will be determined to stabilise the yen and avoid moves which would have severe repercussions for Japan's economy.
"Rather than taking the market on in an arm-wrestling competition to get dollar/yen to a much higher level, they will try to bring it back to where it was," said Simon Smollett, senior foreign exchange options strategist at Calyon. Allowing the yen to rise beyond the record high of 76.25 per dollar set on Thursday would compound the problems facing Japanese exporters, whose production has been severely disrupted by last week's earthquake and the ensuing nuclear crisis.
It is not in the interests of other G7 countries to allow Japan's economy to contract even more sharply than is already likely. Moreover, intervention is one way for the G7 to show solidarity with Japan as it struggles to cope with the disaster. History is on the side of G7 central banks when they take on the currency markets together.
"You will see an attempt by the market to drive dollar/yen down to test the resolve of the central banks but the central banks will show themselves completely capable of handling that," said Simon Derrick, head of currency research at Bank of New York Mellon.
Economic textbook theory says foreign exchange intervention has less - or no - chance of success if monetary policy is working in the opposite direction.
That means that any central bank intervening to weaken its currency has its work cut out if it is simultaneously raising interest rates.
This is definitely not the case in Japan, which is printing money. Moreover, any yen sold in the currency markets are not going to be reabsorbed via money market operations - that is, left unsterilised in the parlance of the currency markets.
With history and economics on the G7's side, there is more reason than not to suppose it will eventually win the day. "We have got a strong signal from the G7 that they do not want dollar/yen to break below 80 on a sustained basis," said Chris Turner, head of foreign exchange strategy at ING. "And from the Plaza Accord onwards, when you get everyone on side, the G7 is effective."