Currency war risk highest in emerging markets, says ING IM

The greatest risk of a currency war breaking out involves emerging market countries whose exports compete with those from Japan, according to the view of ING Investment Management.

It has said that the likelihood of a currency war between members of the G7 is very low following the meeting of that organisation in the past week, despite the ongoing efforts of both Switzerland and Japan (one of the G7) among developed markets to push down the value of their respective currencies.

The commodity currencies – Australian, New Zealand and Canadian dollars – are seen as over-valued currently by ING IM, but these countries still do not seem willing to push competitive depreciation.

Jaco Rouw, senior portfolio manager at ING Investment Management, said: “With the G3 economy still operating well below capacity limits, this is not a worrying development. The main risks are in the emerging world. Japan’s export competitors in Asia might react to the recent yen weakness with foreign exchange interventions, capital controls or interest rate cuts. If Japan in its turn responds with policy measures to weaken the yen, we are close to a currency war. In this scenario, Asian currencies – which have been preferred longs of investors – could see further weakness.”

A key point to note is that because developed market currencies are free floating, it is more likely that fiscal and monetary policy will be used to push down the value of currencies, rather than outright devaluations sparked by exchange rate policy.

Rouw added: “The last time the developed world faced a currency war was in the 1930s. In 1931, sterling was taken from the Gold Standard and was devalued against gold, hence the ‘gold bloc’ currencies. In subsequent years, this was followed by the abandonment of the Gold Standard by other currencies. So, why a currency ‘war’? Firstly, because early leavers clearly gained a competitive advantage, so it could be seen as a ‘beggar-thy-neighbour’ policy. Secondly, in the 1930’s the domestic economic situation was horrible for the relevant countries. Admittedly, the economic cycle is not great at the moment, but it’s not that disastrous either.”

 

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