Will Currency Carry Trades Stage a Reverse Comeback?

In July of 2007, the British Pound (“GBP”) vs the Japanese Yen (“JPY”) hit a price of 251.  That is, a single British Pound would get you 251 Japanese Yen.  It was a great time for UK residents to visit Japan.

By January of 2012, that same British Pound would only get you 119 Japanese Yen.  The relative value of the GBP vs the JPY had fallen be more than 50% in just four and a half years.  This time period saw numerous wealthy Japanese residents buying London properties with their (relatively) stronger Yen.

The macro forces that drove the GBP/JPY higher in the early and mid-2000’s was an expectation of rising short term interest rates in the UK (6% and trending higher), and the expectation for falling short term interest rates in Japan (0.3% and trending lower).  Essentially you could borrow cheaply in Japan and invest at higher rates in the UK.  This is what drove the currency pair to new highs.

And now we see the European Union’s Central Bank promising to fight deflation by lowering short term interest rates.  And on the other side of the world, the Bank of Japan is promising to do increase inflation rates in Japan by any means necessary.

So if the EU is actively dropping interest rates, and the BOJ is working to increase interest rates, is it possible that this year’s carry trade will be long JPY and short EUR?

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