New kind of currency war has central banks vying for strength

Inflation is turning the tide.
Image: Bloomberg

Raging inflation is flipping the definition of currency wars, turning them into a race to the top instead of the bottom.

The way these battles conventionally work is this: a country tries to weaken its currency, to give it an advantage in global trade. It’s what President Donald Trump threatened to do with China, which he accused of intentionally devaluing the yuan.

But soaring inflation has changed priorities, since a stronger currency tends to help contain inflation by making imported goods cheaper. Strategists at TD Securities discussed the issue in a Wednesday note titled “Currency Wars in Reverse Got Markets in a Tizzy,” arguing that policy makers now prefer strength because of the “inflationary impulse that has gripped markets over the past few quarters,” they wrote.

Export-dependent nations often favour cheap currencies to maintain a relative trade advantage against peers. Faced with stagnating global trade following the 2008 financial crisis, some economies attempted to devalue their currencies to boost exports.

Today, a strong currency can ease price pressures as imports become more attractive. Higher central bank policy rates can help bring that about. A Federal Reserve increase is probable next month, and even the doves at the European Central Bank look like they’re headed toward their first hike in a decade.

“The shift by European central banks has completely caught markets off guard, leading to a rise in global real rates and a drop in negative-yielding debt,” according to the TD report. “Markets will likely remain in price discovery mode ahead of the Fed lift-off, underscoring greater two-way risks amid high levels of geopolitical uncertainty.”

A gauge of the dollar’s strength fell on Wednesday as rising commodity prices helped boost risk-sensitive currencies. Meanwhile, the euro got a boost from rising equities, and from a continued shift in rhetoric from European policy makers.

© 2022 Bloomberg

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