The latest entrant in what has become known as “currency wars” – where countries, large and small, vie to weaken their currencies to make their exports more attractive – seems to be the usually restrained European Central Bank (ECB).
Last week, ECB President Mario Draghi broke with the unwritten tradition of presidents before him of not commenting on the euro’s exchange rate, saying that the central bank was watching to see whether the euro’s appreciation was sustained and whether it would affect price stability; he also said that the issue would probably be discussed at the G20 meeting.
But, argues Societe Generale analyst Anatoli Annenkov, the ECB will need more evidence before it joins the currency war with facts rather than just words.
“To our minds, a material deteriorating of the growth and inflation outlook would be needed for the ECB to consider further rate cuts,” Annenkov wrote in a market note.
“Still, given that the ECB’s balance sheet is the only one to contract and given its institutional setting (no quantitative easing à la Fed and Bank of England, strong target independence), there is a risk that the euro could be squeezed in a setting of further global monetary easing,” he added.
Annenkov believes the forthcoming G20 meeting will be “closely scrutinized for any exchange rate implications” and argues that further coordination of the positions of eurozone policy makers at the G20 may be helpful but “positions remain widely different between France and Germany.”
Politicians in the eurozone, among them German Chancellor Angela Merkel, have expressed concern about the measures taken recently by the Bank of Japan to keep the appreciation of the yen under control.
FOCUS ON JAPAN
But while Merkel praised the ECB for not joining the currency war and German officials insist the exchange rate must be set by the markets, French President Francois Hollande has called for some sort of management of the single currency.
The Bank of Japan adopted a 2% target for inflation and announced a shift to “open-ended” asset-buying as ways to fight deflation.
The news sent the yen sharply down versus the major currencies late last month and earlier in February.
But ahead of Friday’s G20 meeting the Japanese currency has been strengthening, with analysts saying the move reflects some concern among market participants that the meeting could be used as a forum to highlight international opposition to the Japanese authorities’ attempts to weaken the currency.
Contributing to the Japanese currency’s latest appreciation were comments by Japan’s Finance Minister Taro Aso that the yen had weakened more than intended, reported by Reuters last Friday. Bloomberg reported that Aso also said the pace of the yen depreciation was too fast. “The comments have created some confusion among investors in the near-term regarding the government’s yen policy, although in the long run it remains more clear that they still see a weaker yen as part of the solution to defeat deflation,” Lee Hardman, a currency analyst with Bank of Tokyo Mitsubishi UFJ, said.
Hardman noted that according to the current plans, the size of the asset purchase programme by the Bank of Japan, as a percentage of gross domestic product (GDP), is already scheduled to overtake the size of the Federal Reserve’s by the end of this year, and this will help weaken the yen further.
THE GLASS IS HALF FULL
But this is unlikely to pose grave problems to the world economy.
In previous years, notes Capital Economics’ senior global economist Andrew Kenningham, the Chinese yuan’s exchange rate was the “most contentious issue” at G20 meetings.
But now the US has softened its tone versus China, possibly because the People’s Bank of China has slowed the rate at which it accumulates foreign exchange reserves and the Chinese external surplus and the US trade deficit have shrunk compared to their size before the crisis.
Kenningham too believes the yen will be the focus of criticism, but that this will be “misplaced.”
“The 2% inflation target merely brings the Bank of Japan into line with the other major central banks, and the proposed shift to open-ended asset purchases follows a similar move by the Fed,” he said.
Even though it does not seem so at first glance, emerging markets stand to benefit the most from the depreciation of major economies’ currencies.
Because emerging markets are not in a position to adopt quantitative easing themselves – mainly due to high inflation preventing central banks from easing policy too much – their currencies are likely to strengthen, but “the strength of their currencies may be a price worth paying if looser policy helps sustain the recovery in the advanced economies,” Kenningham said.
“In this sense, a prolonged ‘currency war’ may ultimately have positive results: although no country may achieve a competitive advantage, the net result of all central banks simultaneously pursuing looser monetary policy may be stronger global growth,” he added.
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