El-Erian: Strong dollar could derail the recovery

El-Erian: Europe QE buys time for policymakers
El-Erian: Europe QE buys time for policymakers   

Mohamed El-Erian, the chief economic adviser to Allianz, has warned that policymakers don't understand how much of a risk a strong dollar and volatile currency markets could pose to market "soundness" and the economic recovery.

The former Pimco chief executive and co-chief investment officer said volatility had returned to currency markets as central banks diverge in their response to lackluster growth and deflation.

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Mohamed El-Erian
Emile Warnsteker | Bloomberg | Getty Images
Mohamed El-Erian

This could result in "excessive movements" in currencies becoming a risk themselves, he said.

"This (the strong dollar) is a key issue and I don't think this is an issue that the markets or the policy makers have understood enough as yet—we have gone from a world where there was relative harmony in what central banks were doing—to a world where there was diverging direction and for good reasons: the economies are doing different things," he told CNBC on Friday.

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"If the other parts of the policy apparatus do not respond, then the only market that accommodates these divergent trends is the currency markets. I could tell you that, as someone who participates in the markets, this poses a threat to volatility and market soundness as a whole and the sorts of excessive movements that may result in currencies becoming a risk themselves to economic recovery," he added.

El-Erian's comments come as the the Russian rouble tumbled to new lows on Friday before bouncing back. The rouble hit its weakest-ever level against the U.S. dollar early on Friday, sliding to 48.6, before recovering to trade at 46.2 within a few hours—1.3 percent higher on the day.

Read MoreRussia ready to defend ruble as rocky ride continues

The dollar has gained against rival currencies, most notably against the euro and the yen, as a result of the divergence in monetary policy between the U.S. and other nations.

The Federal Reserve is winding down is quantitative easing (QE) program, which strengthens the dollar, as does the anticipation of higher interest rates, which will attract investors.

El-Erian: Deflation scenario for Europe a 'risk'
El-Erian: Deflation scenario for Europe a 'risk'   

Meanwhile, both European and Japanese central banks are easing monetary policy to combat weak growth, which results in weaker currencies.

El-Erian said he expects the European Central Bank to reveal a full QE program as "part of the journey to buying time for the system to heal", rather than as a means of boosting ailing growth in the euro zone.

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He stressed it wouldn't be as effective as it has been in the U.S.—because it was being introduced much later—but should buy policymakers time to "do the right thing".

The lack of a credible growth model for Europe and Japan was another "major issue" that hadn't been addressed by policymakers to date, El-Erian, who abruptly stepped down as chief executive at Pimco just months before star manager Bill Gross's exit from the firm at the start of the year, added.

"Neither Europe nor Japan are yet to find a new growth model and the temptation when you cannot find a new growth model is to an old one that is less effective. The U.S. has that issue too, but the U.S. is lucky because the private sector is much more entrepreneurial," he said.

- By CNBC's Jenny Cosgrave