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Central Banks Pause, but 'Currency War' Not Over

Marshall Gittler, Head of Global FX Strategy | IronFX Financial Services
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Last week saw a remarkable five of the Group of 10 central banks hold policy board meetings: the Reserve Bank of Australia (RBA), Bank of Canada (BOC), Bank of Japan (BOJ), Bank of England (BoE) and the European Central Bank (ECB). All were on hold and none made any policy moves. Yet the hints that they gave were enough to infer that this is just an interregnum in what's been called the "currency wars."

The meetings made it clear that the "currency wars" are still with us, and clarified each central bank's stance in these wars. It's not yet clear who will "win" the wars by weakening their currency the most, but the U.S. seems set to be a "loser" by having its currency rise in value against the others.

The RBA was first off the block. Governor Glenn Stevens was a bit more upbeat about the economy, which boosted the Australian dollar. But he left open the easing door by reiterating that the benign inflation outlook "would afford scope to ease policy further, should that be necessary to support demand."

(Watch: Willthe RBA Ease in 2013?)

We think that's the key to Australian dollar/ U.S. dollar: the RBA retains its easing bias, and with its cash rate still at the comparatively astronomical level of 3 percent, it's the only major central bank that still has significant room to ease. It's our impression that the RBA is using this leeway as a tool for verbal intervention to keep its currency from appreciating, thereby allowing it to ease without easing, as it were.

The BOC, the only G-10 central bank that's been threatening to hike rates, continued to walk back that threat. Since last April it has been threatening "some modest withdrawal" of its monetary stimulus sometime in the future, but in January it softened its stance by saying that the timing was "less imminent."

It back-pedalled further this month, saying that the existing policy "will likely remain appropriate for a period of time." This statement comes close to the "policy duration effect" that central banks have started to rely on: promising to keep rates low for a long time to enhance the effectiveness of their policy. It's the exact opposite of the threat to withdraw stimulus in the future.

Could this change of heart be related to another point the central bank has made for months that is the "the persistent strength of the Canadian dollar. Last October and December it blamed the strength on "safe haven flows and spill-overs from global monetary policy;" although it's since dropped those comments, the BOC may be starting to think, "if you can't beat 'em, join 'em."

The BOJ was not expected to take any new measures since this was the last meeting under outgoing Governor Masaaki Shirakawa. Nonetheless it was significant that two board members put forward their own easing proposals.

(Read More: Kuroda Will Be the 'Carlos Ghosn' of the BOJ)

Although they were both defeated, the proposals were a public sign that the incoming Governor, Haruhiko Kuroda, will have at least two allies on the existing board. He will also no doubt be able to count on the support of his two new deputy governors, at least at the start. That gives him a majority on the nine-person board and means that the BOJ can start loosening policy right from his first meeting on April 4.

There was no announcement following the BoE meeting, as is the case when the committee doesn't make any changes. In any event, the next change in BoE policy is likely to come from Chancellor George Osborne, who is reportedly considering using his March 20h budget to give the Old Lady of Threadneedle Street more wiggle room.

(Read More: Bank of England Fails to Expand Asset Purchases)

Options said to be under discussion include giving the BoE more time to bring inflation back within its target range; giving it a dual mandate to target both employment and inflation, as the Fed has. Any of these changes would reinforce Osborne's message of "fiscal conservatism and monetary activism," which just happens to be the standard textbook prescription for how to weaken a currency.

By dropping a previous comment he had made about the strength of the euro posing a downside risk to inflation, ECB President Mario Draghi precipitated some short-covering that sent euro/U.S. dollar rocketing (temporarily). But he admitted that the ECB Council had considered a rate cut, and since they revised down their inflation forecasts for next year to 1.3 percent - dangerously low in light of the ECB's inflation target of "less than, but close to, 2 percent" - the decision not to cut rates seems to be based largely on the hope that their forecast of a recovery in the second-half comes true.

Additionally, Draghi's statement in his press conference that "Our monetary policy will remain accommodative as long as needed" was a notable change of tone from someone who up to now has insisted that "we never pre-commit." An eventual loosening of stance at the ECB seems probable if the expected recovery fails to arrive in time, as I would expect.

A Motive and a Weapon

In short, last week's five central bank meetings confirmed that at least four of the industrial world's 10 major central banks are still considering easing, and the fifth one (BOC) seems to be moving that way. In some cases, such as Japan and the U.K., the currency seems to be an unspoken target of monetary policy; in others, such as Australia and Canada, the currency is naturally going to be affected by monetary policy regardless of whether that is a deliberate aim.

For forex traders, the important point is that all these central banks have both reasons to ease further and room to ease further: a motive and a weapon, one might say. The U.S. Federal Reserve, on the other hand, is debating whether, when and how to unwind its stimulus policy.

While Fed Chairman Ben Bernanke has assured the markets that quantitative easing will remain firmly in place, there is not much talk nowadays of adding to it any radical new easing measures, such as is the case in Britain and Japan, or even of loosening policy further, such as we hear from Australia and Europe.

We will get more clarification of the US view from the next Federal Open Market Committee meeting on March 19-20. Unless some unforeseen change is announced then, I would expect to see the dollar continue to rally as other countries loosen policy further.

The author is the Head of Global FX Strategy at IronFX, an on-line trading firm specializing in Forex, CFDs on U.S. and U.K. stocks, and commodities. He was previously Head of the Forex Committee at Deutsche Bank Private Wealth Management.