FX intervention may be a losing game

The adverse effects of currency intervention, as a recent foray by the Swiss National Bank (SNB) shows, may deter governments in major economies from entering into an increasingly losing game.

The yen's recent strength, partly on the back of a weaker dollar stemming from concerns about the US economy, has renewed speculation Japanese authorities may intervene to sell the yen.

But, with daily volume of some $3 trillion,some participants say the FX market is too large for authorities to control the levels of major currencies. Recent cases have also shown market volatility actually rises after intervention.

"The SNB used unprecedented amounts to buy foreign currencies, and at best only slowed the pace of (Swiss franc) appreciation, but it increased volatility," said Derek Halpenny, European head of global currency research at Bank of Tokyo-Mitsubishi UFJ.

"That is what makes it a difficult proposition for some countries like Japan, which seeks orderly moves."

When the SNB in June ended its 15-month-old policy of holding down the Swiss franc against the euro, the Swiss currency hit a record high of 1.3070 francs two weeks later. It was trading around 1.3540 on Friday .

"Given the nature of the market, currency intervention can later on cause sharp swings in the opposite direction (to) what was intended," one senior foreign exchange trader said.

SNB chairman Philipp Hildebrand has also come under fire for losses of some 14 billion Swiss francs on the central bank's books from its franc-selling intervention. Some say that would make it more difficult to justify intervention going forward.

Simon Derrick, head of currency research at Bank of New York Mellon in London, said the SNB's intervention was "not a great experience" and it would probably take a different approach in the future.

"People were buying into the Swiss franc as a safe haven, and the SNB gave them the opportunity to buy at artificially cheaper levels," he said.

Currency speculators still held net long positions in the Swiss franc in the week ended July 20, Commodity Futures Trading Commission data showed.

Tokyo may take heed of such issues surrounding currency intervention given its limited success in the past.

In any case, market participants do not expect Japan to conduct actual intervention unless the dollar drops to an all-time low below 80 yen .

Furthermore, Japan would find it extremely difficult politically to intervene when global pressure is on China to free up its currency.

One-month risk reversals  also show a softer bias toward a higher yen and are nowhere near levels that would trigger intervention, option traders say.

Tokyo spent 35 trillion yen in a 15-month period that ended in March 2004. It has since refrained from overt intervention, even as the yen hit a 14-year high of 84.82 yen last November.

Other major monetary authorities also seem wary of intervention.

The United States and Britain have refrained from seeking specific levels in their currencies as a policy tool, while the European Central Bank's only public foray in the euro's 11-year history was in 2000, when it intervened along with its Group of Seven partners to prop up the single currency.