A weaker dollar could be doing the work of global central banks.
The greenback begins 2018 after its worst year since 2003, and analysts at Bank of New York Mellon Corp. and Credit Agricole SA say further declines could mean central banks don’t have to tighten monetary policy as much as they may now be planning.
The argument goes that by forcing up rival exchange rates, a decline in the U.S. currency could slow economic growth and inflation elsewhere, creating room for interest rates to stay lower than they otherwise would be.
“A weaker dollar can potentially have an impact on other central banks,” said Mohit Kumar, Credit Agricole’s London-based head of interest-rates strategy. “From a broader perspective, a stronger currency is akin to tightening of monetary policy.
At BNY Mellon, senior currency strategist Neil Mellor told clients this week in a report that “marked currency appreciation has the potential to eviscerate forecasts for reviving inflation, which points to the possibility of any tentative plans for policy changes being placed on ice.”
With the euro already close to a three-year high against the dollar, a further slide in the U.S. currency may have implications for the European Central Bank’s path away from its stimulus plan. President Mario Draghi has previously stepped in to curb the surge in the euro, warning in September that currency volatility could have detrimental impact on price stability.
“It is hard to see the ECB accelerating the pace of tapering if the euro goes on rising,” said Kit Juckes, a global fixed-income strategist at Societe Generale SA. “The risk is that we never get escape velocity.”
The Chinese yuan had its best performance last year since 2008, the yen gained the most against the dollar since 2011, South Korea’s won had its biggest gain since 2004 and India’s rupee had its best year since 2010.
Stronger currencies in Asia are already “doing monetary policy tightening that Asian policy makers would be comfortable with,” said Rob Subbaraman, head of emerging markets economics at Nomura Holdings Inc. in Singapore.
The gains should contain inflation by making exports costlier and imports cheaper. If prices don’t pick up, the risk for central banks is that their easy policies end up creating bubbles in asset markets and leave them without ammunition to fight the next crisis.
“If you get dollar weakness that implies strength of emerging market currencies and it means emerging market central banks don’t need to be as aggressive themselves in putting their foot on the brake,” said Dwyfor Evans, head of Asia Pacific macro strategy with State Street Global Markets in Hong Kong.
Still, the softer U.S. dollar could be a reason for the Federal Reserve to push rates up faster than it now anticipates, pressuring Asia’s central banks to respond, said Rajiv Biswas, chief Asia-Pacific economist at IHS Markit in Singapore.
“Despite the current weakness of the dollar, Asian central banks are likely to remain concerned about upside risks to inflation and of faster-than-expected tightening by the Fed,” he said.