Currency wars risk dangerous escalation

Another volley of shots has been fired in the currency wars with the Bank of Japan raising its inflation target to 2% from 1% and committing to open-ended monetary easing next year, which is partly designed to weaken the JPY. This is likely to unleash a series of reactionary events from across the globe.

The Japanese yen rallied on the announcement — a case of buy on the rumor, sell on the news. It wasn't as strident as some in the markets had expected. However, the direction of travel is very clear.

It's a very worrying escalation in the currency wars to see the world's third largest economy so openly attempting to devalue its currency in the face of G20 commitments not to do so. Also, of concern is that the Bank of Japan has been “bullied” into this position by the newly elected government of Prime Minister Shinzo Abe. It represents a further slide toward central banks becoming politicized and therefore less independent. In the long run that is likely to damage their credibility with the markets.

On top of that, the current BoJ governor, Masaaki Shirakawa, steps down in April and Abe has talked about finding a replacement who “fully understands that the Bank of Japan has a big role and a clear role in maximizing jobs.” Rhetoric that echoes the U.S. Federal Reserve's commitment to target a US unemployment rate of 6.5%. That suggests that the next governor of the BoJ may well pursue its new mandate aggressively.

USD/JPY Chart

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