With currency war talk distracting investors and policy makers from the more serious and significant issues, the G7 issued a statement today reiterating its "longstanding commitment" to market determined foreign exchange rates.
Fiscal and monetary policy is directed to domestic policy objectives and not a foreign exchange target. At the same time, it recognizes that excess volatility can generate disorderly markets, which in turn, may have a negative feedback on the economies and financial market stability.
It is true that some comments by senior Japanese government officials seemed to have violated these principles, but in the past few days, we argue, there has been a shift in the rhetoric, away from providing guidance for the dollar-yen exchange rate.
However, what ought not be lost in translation is that Japan's policy of reflation, dubbed Abenomics, has been effectively endorsed. After years of calling for Japan to take stronger action, it is difficult now to be critical of its policy.
The IMF and the US Treasury, through Brainard's comments yesterday, have seemed to offer positive endorsement for the stimulative policies. Indeed, it appears to have been Brainard's comments that prompted the late-US afternoon dollar spike to JPY94.50 (new highs for the move) and a level that has not been seen again. That said, new dollar and euro highs against the yen should be expected.
De-emphasizing the currency war talk should be euro positive (as well as yen negative) as some observers read too much into Draghi's press conference remarks last week. He had to acknowledge the French calls for action and reassure that the ECB was closely monitoring developments. Some has thought the official pain threshold for the euro had been reached, but the G7 reaffirmation and Constancio's comments today suggest otherwise. A move now above $1.3480-$1.3520 would help lift sentiment and begin repairing the technical damage inflicted last week.
On another front, the currency war theme obscures the importance of the debate within the euro area itself. The fault line is familiar. Northern Europe is more competitive and can be with a higher exchange rate than the less competitive South. There is no doubt that France and Germany, the two pillars of Europe, are on different sides of the issue--not so much, we would argue, due to philosophical differences but concrete differences.
Sterling and the dollar-bloc continue to have a rough ride, with new lows having been recorded for the Australian and Canadian dollars and sterling today. After the yen, these are the three weakest major currencies thus far this year. The yen has lost about 8%, sterling 4% and the Aussie and CAD are off about 1.5%.
Sterling showed little reaction to the erosion in the RICS house price index (-4 from -1 in Dec), but sold-off in early Europe before the inflation report. In January CPI remained, as it has through Q4 12, at 2.7%, which is the highest since last May. Perhaps more concerning for investors was the PPI report that warned of a potential squeeze on profits. Input prices rose 1.3%, half again as much as the consensus expected, with output prices rose a mere 0.2%. Sterling bounced off the low near $1.5575, after the barriers thought to have been struck near $1.56 were taken out. Resistance is now seen in the $1.5650-70 area.