Specter of Currency War Re-Emerges With Central Bank Skirmishes

Growing unease among global central banks about the slumping U.S. dollar has ignited speculation that a fresh currency war might be on the horizon.

European Central Bank official Philip Lane this week fired a warning shot, explicitly drawing attention to the exchange rate as the euro topped $1.20 for the first time in two years. Reserve Bank of New Zealand boss Adrian Orr was more circumspect about exchange rates, but nevertheless signaled he would ease monetary policy as necessary to stimulate growth. And other central banks from the U.K. to Japan also appear willing to loosen the spigots.

“A new ‘currency war’ may not be at hand just yet, but the subtle pushback seen from major central banks is noteworthy,” said Ben Emons, managing director at Medley Global Advisors. “When the U.S. dollar is on the move, there comes a point where central banks will react because a substantially weaker or stronger dollar has implications for global monetary policy.”

The slide in the dollar is adding to growth and disinflation concerns for economies outside the U.S. at a time when the world is already struggling with the fallout from the coronavirus pandemic. The greenback has fallen more than 10% from its March peak, based on a Bloomberg gauge of the currency, although it has recovered some ground this week in light of central bank comments.

A weakening currency is generally seen as beneficial for spurring growth and inflation, and central banks have a number of tools at their disposal to help influence exchange rates. These can range from so-called jawboning -- publicly verbalizing concern about foreign-exchange strength -- to more concrete actions such as selling the currency in markets or lowering interest rates. When these come into conflict with what other countries are doing, a currency war can result.

The ECB‘s Lane suggested earlier this week that the euro’s level “does matter” for monetary policy, while the Financial Times has reported that policy makers at the central bank are concerned that euro strength will weigh on exports and bring down prices. Traders will be keeping a keen eye out for any comments about the currency at next weeks ECB policy meeting.

Bank of England Deputy Governor Dave Ramsden, meanwhile, has said that officials in the U.K. have capacity to increase bond buying if needed, and the Bank of Japans Masazumi Wakatabe highlighted the need to be alert for softening inflation.

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Yet while there has been a substantial weakening of the greenback of late, that fall has been from historic highs and the currency is still above its average levels from the past decade.

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Any move to push back against the declining dollar would, of course, risk attracting the ire of the U.S. and in particular President Donald Trump. The American leader, who is set to face the judgment of voters in November, has previously complained about dollar strength and last year chided the ECB when it signaled a willingness to cut interest rates further below zero to shore up economic growth.

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Global finance chiefs have previously agreed that the international tit-for-tat of a currency war is in nobody‘s interests. Central bankers are therefore likely to remain guarded in how they approach the sensitive topic of exchange rates -- but that doesn’t mean they will be silent.

— With assistance by Liz McCormick