Yen weakness challenges other central banks Shinzo Abe, Japan's prime minister, is casting the December snap election as a vote of confidence in Abenomics. Investors are betting that, whatever the political fallout, the thrust of monetary policy will remain unchanged - and with it, the bearish outlook for the yen. The currency has already fallen more than 7 per cent against a resurgent dollar since the end of October, when the US Federal Reserve ended asset purchases and the Bank of Japan ramped up its own programme in an aggressive bid to reflate the economy. Mr Abe's decision to delay the sales tax rise, and the expectation that he will soon step up fiscal stimulus, should reinforce that trend. But the analysts now slashing their long-term forecasts for the yen are making two assumptions independent of politics: that Haruhiko Kuroda, the central bank governor, will persuade his colleagues of the need for even more monetary easing over the course of next year and that Japanese investors are following the lead set by the government pension fund (GPIF) and are finally starting to shift funds overseas. "It is the Bank of Japan's unwavering commitment to its inflation objective that will be market moving," says Stephen Jen, of the hedge fund SLJMacro Partners. Whether Mr Kuroda will succeed in getting inflation back up to 2 per cent by next April is less important than him continuing trying. Mr Kuroda won support for last month's extension of the stimulus programme from all but one of Japan's monetary policy committee on Wednesday. He warned afterwards that inflation could fall below 1 per cent next year - a comment that sent the yen down to a fresh seven-year low of Y117.65 to the dollar. "Irrespective of the uncertainty surrounding politics and the effectiveness of current policy, we believe that BoJ resolve should not be in doubt, nor should the risk of material portfolio outflows be dismissed," writes Geoffrey Yu, strategist at UBS. The divergence of US and Japanese monetary policy has created an overwhelming consensus among investors that the yen will continue to depreciate against the dollar. Although some worry that the trade is becoming overcrowded, others are now predicting it will fall past Y120 to the dollar before the end of the year. The implications for other currencies, however, are far less clear cut. Some central banks in the region are worrying that yen depreciation will frustrate their own hopes of a more competitive currency. The Australian and New Zealand dollars - traditional targets of the yen carry trade - have gained about 5.5 per cent and 8 per cent respectively against the yen so far this month. The Reserve Bank of Australia warned this week that BoJ easing, combined with the GPIF's shift towards foreign bonds and equities, "could hold the Australian dollar at a higher level than economic fundamentals would imply." However, analysts say that falling commodity prices, combined with rising volatility in currency markets, limit the scope for gains in the aussie and kiwi. The long dollar trade is a huge consensual position but there are good reasons for it. It's hard to see a case for carry to outperform," says Peter Kinsella, strategist at Commerzbank, who expects investors to dump the aussie and kiwi in favour of the greenback. Japanese easing might trigger a policy response from trade rivals worried about the effects on their exporters. South Korea's central bank - which has watched the won gain almost 60 per cent against the yen in three years - did not cut interest rates in the wake of the BoJ's move, but it did flag up the exchange rate in its latest policy statement, and could act to limit further currency strength. Analysts at Barclays also identify Taiwan, the Czech Republic and Thailand as key competitors with Japan in export markets, and think emerging markets policy makers "will remain vigilant against sharp currency appreciation against the yen." The bigger influence on emerging markets currencies, however, could be the changing behaviour of Japanese institutional investors, who have traditionally favoured US and European assets when buying overseas. Mr Yu argues that while the GPIF may act on its new targets only gradually, "the biggest effect could well be in the messaging," prompting other Japanese investors to buy overseas assets without hedging currency risk as they have in the past. Adam Cole, a strategist at RBC Capital Markets, thinks an important shift is already taking place. Japanese demand for foreign equities, neutral for years, has surged since June, he notes. But flows to the US and EU no longer dominate: instead, funds are flowing increasingly to emerging markets in Asia and Latin America, including South Korea, Taiwan, India and Brazil. Could this be the work of a single large player - meaning that the GPIF began reallocating funds even before announcing its new targets? If so, Mr Cole argues, similar flows are likely to continue - and given the high cost of hedging currency risk in most of the countries concerned, they are likely to be unhedged. This can only steepen the yen's slide.