Dollar Weakness Gives World's Central Bankers New Headache

The dollar's continued slump against a range of global currencies is making life more complicated for central bankers outside the U.S., putting downward pressure on inflation at a time when many are contemplating how to exit from years of loose policy.

The dollar's decline overnight extended into Asian trading hours Thursday. The ICE U.S. dollar index, which measures the U.S. currency against six of its peers, fell 0.2% to its lowest level in more than a year. That came after the Federal Reserve's latest policy statement, which indicated that officials have become more concerned about a recent slowdown in domestic inflation.

The dollar's slide this week extends a run of weakness for the greenback in recent months that has fully reversed its surge in the wake of U.S. elections last November.

The euro and Australian dollar have both surged more than 11% against the dollar this year, while the British pound has gained 6.4% and the Japanese yen has risen 5.2%. On Thursday the Aussie dollar hit its highest level since May 2015 at $0.8020, while the Chinese central bank set the yuan at its highest level against the dollar since Oct. 18 at 6.7307 per dollar.

The Fed's recent caution, as well as waning optimism over the pace at which President Donald Trump's economic policies might take effect, have contributed to the dollar's recent weakness. Investors now see a less-than 50% chance that the Fed will raise rates again this year, according to data from CME Group.

For central bankers in places like Europe and Japan that have fought long struggles against low inflation, the dollar's weakness is adding another wrinkle. A stronger currency tends to drag on inflation, since it makes imported goods and services less expensive. It can also weigh on growth for trade-reliant economies, as it makes a country's exports more expensive in dollar terms.

"Clearly, both yen and euro appreciation have been unwelcome" given low inflation around the world, Joachim Fels, global economic adviser at fund manager Pacific Investment Management Co., said in a note Wednesday.

While central bankers tend to couch any concerns in cautious language, several have noted currency moves in recent communications.

European Central Bank President Mario Draghi said last week that "the repricing of the exchange rate has received some attention" during the central bank's latest meeting.

Mr. Draghi described the economic recovery in the eurozone as "robust" but also highlighted the region's low inflation, suggesting the bank's stimulus efforts could need to remain in place for a while longer. A stronger euro only complicates that calculus, since it should curb inflation.

For sure, several analysts argue that rising currencies can be taken as a sign that the global economy is in reasonable health, and that they shouldn't derail central bankers from any plans to tighten policy.

"There seems to be some degree of consensus among global central banks that the forces that are capping price pressures are likely to be transitory," said Todd Elmer, head of G10 FX strategy for Asia at Citi in Singapore.

Still, for export-reliant economies like Japan, the yen's strength this year has given the central bank another headache. The yen has risen 0.6% against the dollar in the past two days.

The Bank of Japan has been trying to raise the country's stubbornly low inflation for years by continuing to buy up trillions of yen's worth of government bonds. Last week, though, it again pushed back the date when it expects to achieve its 2% inflation target.

Australia's central bank has meanwhile described the gains in its currency against the U.S. dollar this year as "not helpful." Consumer prices rose more slowly than expected in the second quarter, according to data released Wednesday, prompting markets to wind back their expectations for when interest rates will be raised.

Even if the Reserve Bank of Australia wants to join other central banks in raising interest rates, it is now effectively paralyzed, said Michael Blythe, chief economist at the Commonwealth Bank of Australia.

"The RBA clearly is in no hurry to lift rates...inflation remains dead in the water," he said.

Currency gains haven't been confined to developed markets this year: emerging-market currencies have soared as investors continue to plow money into stocks and bonds in those countries in search of higher returns. Some analysts say central banks in Asia could prove more tolerant of currency gains because their growth has been solid, driven by robust exports.

The Korean won has rallied more than 8% against the dollar, while the Indian rupee is up 6% and the Brazilian real has gained 3.7%.

Chelsey Dulaney contributed to this article

Write to Saumya Vaishampayan at saumya.vaishampayan@wsj.com and James Glynn at james.glynn@wsj.com

(END) Dow Jones Newswires

July 27, 2017 07:26 ET (11:26 GMT)