The introduction of negative interest rates by The Bank of Japan (BoJ) last month has renewed concerns of a global currency war, says BNP Paribas.
BNP Paribas senior economist, greater China, Chi Lo said the BoJ’s move to a negative interest rates places further pressure on the European Central Bank (ECB) and the People’s Bank of China (PBoC).
"For the currency market, the latest move by the BoJ is reviving the currency war dynamics, which may increase in intensity this time around," he said.
In a new article, Mr Lo explained that the risk of a weakening Japanese Yen (JPY) will prompt a stronger response from the ECB. If the ECB’s response results in the further weakening of the euro, this could strengthen the US dollar.
A rising US dollar, said Mr Lo, will push up the renminbi’s (CNY) trade-weighted exchange rate, questioning the sustainability of the current, and stable, CNY-USD cross rate conditions.
“If the PBoC is really targeting a stable trade-weighted exchange rate, as we believe it is, then it may allow more CNY depreciation against the USD as an adjustment to keep the trade-weighted exchange rate stable,” said Mr Lo.
Moreover, the PBoC’s foreign exchange policy goal remains unclear. He asked: does it want to target a stable exchange rate? Or does it want to keep the trade-weighted exchange rate within a targeted range?
“This uncertainty is bad enough to create more market volatility on the back of a weakening JPY for both China and the world markets.
“If the renminbi does weaken against the USD further, courtesy of a weakening JPY, Asian currencies will be dragged down further," he said.
In addition, further depreciation of the Japanese Yen has a direct impact on trade throughout Asia.
Referring to the United Nations Comtrade database, Mr Lo said Korea has the biggest export similarity, of 59.9 per cent, with Japan, making the country vulnerable to depreciation pressure. Taiwan, Singapore and Thailand also have more than 40 per cent of their exports competing with that of Japan, making their currencies vulnerable to the yen's weakness.
Further, Mr Lo noted that China has 39 per cent of exports similar to those of Japan.
Mr Lo said monetary policy divergence and the continued strength of the US dollar are likely to be the more "crucial trends" affecting global markets this year.