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Central Banks Run the “Race to Debase”

Central Banks Run the “Race to Debase”

Kathy Lien, Technical Strategist

With central banks all over the world taking various actions to weaken their currencies, the efforts seem to be offsetting each other, causing general consolidation among the dollar, euro, yen, and commodity dollars.

No countries are willing to admit it, but the currency war is on. Over the past week, we have seen a number of central banks take action to devalue their currencies. The European Central Bank (ECB) and Reserve Bank of Australia (RBA) both cut interest rates by 25 basis points (bps) to record lows, and last night, we learned that the Reserve Bank of New Zealand (RBNZ) sold its currency to cap its rally.

Of course, we can't forget that the Bank of Japan (BoJ) fired a monetary bazooka last month by announcing a $1.4 trillion quantitative easing (QE) program.

Techniques from the central banks have varied, but the goal has been the same: stimulate the respective economies and boost their competitive advantage by way of a weaker currency.

At a time when growth comes at a premium, every country could use a weaker currency. As a result, central banks around the world have been fighting hard to prevent their currencies from appreciating. The Federal Reserve, BoJ, and Bank of England (BoE) are buying bonds, the ECB and RBA cut interest rates, and the RBNZ intervened in its currency directly.

That decision by the RBNZ to intervene instead of cutting interest rates was particularly interesting since New Zealand has plenty of room to lower rates. This was clearly a conscious decision on the Bank’s part to focus on capping the currency's rise.

According to the charts, the "intervention" appears to have occurred on April 15, which suggests that 86 cents versus the US dollar is the pain threshold for the currency. The RBA also said a strong currency was the motivation for this week's rate cut.

The choice of technique in a currency war depends on a central bank's level of aggressiveness and availability of other measures (US and Japanese rates are already at zero). However, with central banks around the world trying to depreciate their currencies at the same time, their efforts are offsetting each other and leading to consolidative price action in currencies.

In other words, the reason why we haven't seen any breakout moves in FX over the past three months is because of all of the shots taken by central banks around the world. Until one comes to the currency war with a machine gun in tow, currencies could be stuck in their current range.

More: See the multi-part article series “The Fuel of a Currency War

The one unambiguous benefit of the currency war, however, is cheaper financing for individuals and corporations, which is why equities are on tear. Central banks are flooding the market with different forms of liquidity and making life easier by weakening their currencies.

Eventually, this should translate into stronger business and consumer confidence, and hopefully more robust spending, but for the time being, while inflationary pressures are low, more shots could be fired in the ongoing currency war.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.