Is a Currency War about to break out?

With the upcoming G20 meeting, all of the recent discussion in forex trading circles has been about a potential currency war.  The Bank of Japan, driven by new Prime Minister Shinzo Abe, looks determined to devalue the Yen, but with many of the G20 nations opposing the idea, what can we expect to see in the future?

Is a currency war about to break out?

“Currency war” has been on the lips of many forex traders in the last few weeks, with talk intensifying as the upcoming G20 meeting approaches.  The term is used to summarise a country’s intent on devaluing its sovereign currency, which in turn makes the real price of their exports cheaper.  This is done to spark interest from other nations for the exports, thus fuelling growth in the manufacturing industries, leading to growth in employment and, eventually, the economy.

All eyes have turned to Moscow for the G20 meetings, with currency wars at the forefront of most ministers’ minds, even if not officially acknowledged.  It is likely to be the developing economies of the group that will be raising the most vocal protests against nations attempting to lower their currencies.  For “nations”, read: “Japan”, despite Canadian Finance Minister Jim Flaherty saying that no one is trying to “single out” the Land of the Rising Sun.

All this has come after some recent extreme movements in the currency market, particularly those pairs involving the Yen.  It has prompted the G7 group of nations to announce that they would “consult closely” on any foreign exchange action that looks to be targeting exchange rates.

It would appear that Japan is being outnumbered, but many with Abe’s new government (and almost certainly his yet-to-be-revealed BoJ governor) that they are left with little choice in their attempts to finally stimulate an economy that has been completely flat for 25 years.  The G7 has long advocated the cutting of interest rates as an “acceptable” domestic policy tool to stimulate growth, but when your interest rates are already literally rock-bottom, where else can you go?

So, despite the US treasury warning that “for the market process to work, exchange rates must be allowed to reflect market forces”, it does not appear likely that Abe and his government will stop their intention to devalue the Yen any time soon.  They are not completely without friends, either.  Somewhat predictably, Russia has countered the US’ thinly-veiled attack by proclaiming that the Yen had definitely been over-valued and that “there are no signs” Japan’s monetary authorities were intervening.

This is likely to mean that even a forthright announcement by a G20 nation is unlikely to halt Japan’s intended policy.  With the forex market regaining a risk appetite somewhat and with encouraging news from the euro zone, bolstered by the US-EU free trade talks, the EUR/JPY  pair may continue to rise and test the 130.00 level, possibly breaking it and going further. It should be remembered, however, that this currency pair was languishing at the 95.00 level six months ago and we all know that forex is never a clear-cut trend in one direction.  However, 125-130.00 does appear to be an acceptable “range” for the EUR/JPY.