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Euro joins the currency war, sits near 3-month low

Here we go again.

European Central Bank President Mario Draghi has fired the latest salvo in the global currency war, a post-crisis strategy where central banks indirectly devalue their currencies to help pump up exports and economic growth.

Just before Draghi's press conference last week, the euro was soaring and just about to hit 1.40, for the first time since October 2011.

Mario Draghi, President of the European Central Bank
Daniel Roland | AFP | Getty Images
Mario Draghi, President of the European Central Bank

Then he uttered the magic words, "comfortable with acting next time" and the euro has been on a one-way ticket down. It's now sitting at nearly three-month lows against the dollar and the yen.

With those words, Draghi raised expectations of easing policy in June.

"The ECB has now officially joined the increasing list of central banks directly or indirectly targeting their exchange rate since the global financial crisis," wrote Bank of America Merrill Lynch strategists led by Athanasios Vamvakidis after the meeting.

"The ECB's references against euro strengthening—rather than calling directly for a weaker currency—to address deflation risks do not cross the line of G20 commitments against beggar-thy-neighbor policies in our view, but certainly are not fully consistent with market-driven exchange rates," they added.

In other words, the ECB isn't breaking any international taboos of directly intervening in the currency market, but indirectly, it's talking the euro down.

Talk is one thing, action is another. Strategists say for the euro to continue weakening, Draghi must pull the trigger. The question is what will he do?

Read More Europe's crisis not over yet: IMF's Lagarde

Reports indicate the ECB is prepping a mix of policies including cutting interest rates and targeted measures to boost lending to small and mid-sized businesses. Reuters mentioned deposit rates going negative for the first time, citing people familiar with the measures.

What would be the goal of this? To stimulate bank liquidity in Europe to boost lending, business activity, jobs, growth and inflation.

The side effect and perhaps the most important form of stimulus would come in the form of a weaker euro.

"While it is likely to remain unspoken, the best option for the ECB would probably be a large depreciation of the EUR, aiding export-driven sectors and increasing measured price changes," according to Bob Sinche, FX strategist at Pierpont Securities.

It's a page right out of the post-crisis central bank playbook. First came the Fed, then the Bank of Japan, and now it's the ECB's turn.

So will Draghi win the currency war by managing to steer the currency to sustained weakness?

"It is going to win only by default," according to FX strategist Sebastien Galy of Societe Generale. "The ECB is targeting the expensive Euro via negative interest rates trying to frighten reserve managers into either extending the maturity of their money market positions, deposit with commercial banks or reduce their euro exposure. "

Read MoreEurope closes lower on disappointing GDP data

What is the problem with the currency war? Everyone must defend their own currencies from losing or getting too strong.

Namely, emerging markets currencies have been the losers, with their currencies strengthening against the more dovish developed markets.

In a Brown Brothers Harriman note this week, strategists led by Marc Chandler wrote, "So now some EM central banks are changing sides in the market from selling to buying dollars. No, currency wars are not back. But yes, we are seeing a pickup in FX intervention, notably in Korea, Colombia, Brazil and Israel."

Here we go again.

Federal Reserve Chair Janet Yellen has maintained that interest rates are not set to rise anytime soon, and the bond market has backed that up. Bank of Japan Governor Haruhiko Kuroda has signaled he's open to further easing if the economy needs it, as part of the bazooka he fired to break the streak of deflation and slow growth.

Now it's Draghi's turn.

He's fired a warning shot. We'll see if he marches on to war.

—By CNBC's Sara Eisen.

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

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