Why Japan buys euro bonds?

The news that Japan is going to buy eurozone bonds has so far had little to solve the problems facing the eurozone countries, though the euro gained a little bit and the eurozone peripheral bonds also climbed a bit in favor of the news.

Japan will purchase euro zone bonds to bolster confidence in the European Financial Stability Facility as the euro zone struggles with a prolonged debt crisis, Japan's finance minister said on Tuesday, boosting the euro.

Tokyo is considering buying about 20 percent of euro zone bonds to be jointly issued later this month to raise funds to support Ireland, using euros in its foreign reserves, Finance Minister Yoshihiko Noda told a news conference.

"I think it's appropriate for Japan to purchase a certain amount of bonds to boost confidence in the EFSF and make a contribution as a major country," he said.

China last week reaffirmed a commitment to buying Spanish bonds and last year offered to buy Greek bonds after Athens had to seek an international bailout.

Noda's comments came after Japan's top currency diplomat, Rintaro Tamaki, said on Monday that Tokyo could consider buying euro zone bonds to support the bloc as it struggles with a debt crisis.

Japan's foreign reserves, the world's second-biggest after China's, stood at $1.10 trillion at the end of December last year, after authorities spent 2.1249 trillion yen ($25.69 billion) on currency intervention in the month to Sept. 28, Ministry of Finance data showed on Tuesday.

The euro rose as far as $1.2992 on trading platform EBS from around $1.2925 after Noda's comments, pulling further away from a four-month low hit on Monday, although it later moved back to $1.2961. Against the yen, the euro rose as high as 107.86 yen.

"I don't think these comments change the backdrop for the euro at all," said Todd Elmer, currency strategist for Citi in Singapore.

"Despite the fact that we're seeing this groundswell of international support, it doesn't really change or address the underlying problem and that's not going to change until the European authorities themselves come up with a more comprehensive solution to mitigate the fallout from the debt crisis."

Though Japan's purchase is unlikely to be a comprehensive solution to European problems, the timing of announcement is perfect. The yield spread between German and the eurozone peripheral bonds has been widening again since the start of this year. In fact, the yield of 10-year Spanish government bonds is now around 270bp above that of 10-year German Bunds, the biggest since late November last year.

What made Japan to decide to buy euro bonds? Japan's move is too timely in the midst of widening spreads that it might be a cooperative action to tame the concern for worsening euro crisis between Japan, EU, and probably the US-IMF.

For Japan, purchasing euro bonds has two merits. First, it could diversify from the dollar assets which would lose its values due to the Fed's ultra-loose monetary policy. Second, buying euro would depreciate yen which is now traded at a historically high level against the dollar. Depreciating yen would help exporters revive in the fierce competition against South Korea and China, both of whose currencies are considered to be undervalued.

Likewise, Europe has some merits for Japan's purchase: Japan's money is thought to be "clean" relative to China's, and it could prevent one country (China, for example) from investing too much in euro bonds.

Still, Europe's prospect is so bleak that it's increasingly difficult to find an easy way out from the mess.