The "Big Three" central banks are set to alter the course of the global currency dispute this week - all within a span of about 33 hours.
Bank of Japan governor Masaaki Shirakawa last week rescheduled the next meeting of his policy committee to Thursday and Friday in Tokyo, putting Japan's central bank in a position to respond to the stimulus measures the U.S. Federal Reserve is expected to unveil on Wednesday afternoon in Washington. Between those announcements, the European Central Bank will conclude its latest deliberations in Frankfurt.
Combined with a gathering of the Bank of England's policy committee on Thursday, the meetings represent the biggest concentration of activity by major central banks since the first week of October, 2008, when they held emergency sessions to combat the financial crisis, according to Bloomberg News.
As the guardians of the world's three most widely used currencies - the dollar, the euro and the yen - the decisions the Fed, the ECB and the Bank of Japan take this week will have repercussions in foreign-exchange markets. A little more than a week ago in Gyeongju, South Korea, Fed chairman Ben Bernanke, ECB president Jean-Claude Trichet and Mr. Shirakawa were party to an agreement by Group of 20 finance ministers and central bankers that said advanced economies would be "vigilant against excess volatility" in exchange rates. The G20 statement was a bid by the world's leading economies to ease tensions over currency policy.
Anticipation that the Fed this week will announce plans to create hundreds of billions of dollars to buy financial assets has caused the dollar to fall about 7 per cent against a basket of six major currencies since the end of August. Japan intervened in foreign-exchange markets for the first time in six years to fight the yen's rise, and many emerging-market economies, including Brazil and Thailand, have taken steps to slow the appreciation of their currencies, which hurts their competitiveness by making exported goods more expensive.
Mr. Bernanke's move toward a second round of asset purchases, a strategy called quantitative easing, is controversial at home and abroad. By adding to the supply of dollars, the Fed risks further weakening the currency by encouraging investors to seek out safer havens, including the euro and the yen, which would put upward pressure on those currencies. Most economists expect the Fed will decide on Wednesday to purchase at least $500-billion (U.S.) of securities - probably Treasuries - and to advise market participants that it will purchase more if economic conditions warrant.
In Japan, the central bank's decision to reschedule its policy meeting to follow that of the Fed had "all the subtly of a sledgehammer," said Paul Donovan, a global economist at UBS Securities in London. "It's safe to assume that the Bank of Japan, which worries about the currency and deflation, will react to the Fed decision and probably respond with action of its own."
The Bank of Japan is already buying financial assets in an attempt to snap the Japanese economy out of its prolonged funk. It likely would expand that program to stay in line with whatever the Fed does to keep the yen from appreciating, which would hurt exporters.
Mr. Trichet is in a different position. The ECB's benchmark lending rate is at 1 per cent, extremely low by historical standards, but much higher than in the U.S. and Japan. Mr. Trichet has said recently that ECB policy is "appropriate" and Axel Weber, the head of Germany's central bank and a member of the ECB's governing council, is pressing his colleagues to plan an exit from its crisis-fighting program.
But that doesn't mean the Fed's decision on quantitative easing won't have an effect on ECB policy. Mr. Donovan and his colleagues at UBS last week revised their outlook for when the ECB will raise its benchmark interest rate to the third quarter of next year from the second quarter. The reason: moving before the Fed begins to tighten monetary policy would put too much pressure on the euro.
Policy makers in the U.S., Japan and Europe are fighting sluggish economic growth and high unemployment. In Japan, Mr. Shirakawa is struggling to reverse deflation. Mr. Bernanke is trying to avoid that situation, saying last month that a corrosive downward price spiral like that of Japan's is a threat too great to be ignored. Both the U.S. and Japanese central banks have dropped their benchmark interest rates to near zero.
The Fed doesn't have an explicit inflation target, but in building a case for further unconventional policy measures, Mr. Bernanke last month used a speech to explain that inflation in the U.S. is currently about half of the roughly 2 per cent annual rate that the central bank considers consistent with its mandate to achieve price stability. "They are effectively becoming inflation targeters," said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics in Washington and a former Fed economist.