With the European Central Bank (ECB) recently announcing new stimulus policies, some economists have highlighted that other central banks could be ready to counteract any foreign exchange fluctuations, thus increasing the possibility of a return to "currency wars."
Last week, ECB President Mario Draghi unveiled a promise to buy purchase asset-backed securities (ABS) and covered bonds which will effectively add 1 trillion euros ($1.29 trillion) into the euro zone's flagging economy, according to some analysts.
With more liquidity in the system and Draghi still pondering whether to launch a Federal Reserve-style government bond purchase program, the euro is expected to continue to depreciate against its peers. And this is where the problem lies, according to economists.
"(We expect) talk of currency wars to resume as some central banks will ponder the effect on capital flows and their currencies," Claus Vistesen, the chief euro zone economist at Pantheon Macroeconomics, said in research note after the latest meeting by the ECB's Governing Council.
Japan to ease?
The unwanted consequences of the ECB's asset purchases could be that euro zone banks start lending more to emerging markets (EMs) to earn higher yields, according to Diana Choyleva, the head of macroeconomic research at Lombard Street Research. European bank lending - excluding the U.K. and Switzerland - to EM countries is currently close to its all-time high and is likely to rise further, she notes in her new research released on Monday.
"EU banks have ramped up their lending to developing Asia, a trend that is set to intensify. This will push the euro down," she said.
"But Japan is also likely to redouble its QE (quantitative easing) efforts if it is to achieve its 2 percent inflation target. If both Japan and the euro area go for extensive QE, emerging markets in Asia would suffer as their currencies appreciate.
China to enter?
This, she believes, will mean the Chinese central bank will enter the fray, adding that there would be no way it could restart its "sputtering" growth engine without major yuan devaluation.
"This in turn, together with likely higher U.S. interest rates, would be a lethal combination for the euro area. Ultimately, serial competitive devaluation is not a solution for a global economy that still lacks genuine consumer demand," she said in her note.
Manipulating reserve levels can be one way that a country's central bank can intervene against currency fluctuations along with altering benchmark interest rates and QE. Central banks often iterate that exchange rates are not a primary policy goal and can be seen more as a positive by-product of monetary easing. There have been ongoing discussions in the last few years that countries are purposefully debasing their own currencies to improve competitiveness - a concern that was given the moniker "currency wars," by Brazil's Finance Minister Guido Mantega in September 2010.
That debate came to a head in early 2013 with the Federal Reserve, the Bank of England and the Bank of Japan all undertaking QE programs, but has since cooled significantly with two of the three now looking to normalize interest rates once again.