Decades-high inflation has triggered a 'reverse currency war' as a soaring dollar leaves central banks scrambling to catch up

The pound's dramatic plunge against the dollar has led to calls for the Bank of England to hike interest rates more aggressively.

Reuters

• A "reverse currency war" is breaking out amongst global central banks as they race to keep pace with a rapidly appreciating dollar.
• The Federal Reserve's torrid rate hikes — intended to suppress decades-high inflation — have been a major driver of the greenback gains.
• Japan has already moved to strengthen its currency for the first time in 24 years, while the British pound is fresh off record lows against the dollar.

The dollar's rapid appreciation has central banks around the world engaging in a "reverse currency war" as they battle to keep pace with the Federal Reserve.

The Fed has enacted aggressive interest-rate hikes this year in an attempt to rein in inflation that hit more than 40-year highs over the summer. That's pushed the greenback at least 7% higher versus every G-10 currency in 2022. In fact, it's up more than 20% against both the yen and the British pound, with the latter fresh off a record low.

Now, that strong dollar has sparked a scramble as global central banks look to strengthen their currencies and fight inflation through rate increases of their own. Last week, as the Fed hiked rates for a fifth time this year, a handful of other central banks — including those in the UK, Norway, Switzerland, and Indonesia — raised their benchmarks.

And it hasn't just been rate hikes used by central banks to backstop currencies. The Bank of Japan — which has historically devalued the yen in order to favor its export-driven economy — recently intervened to prop up the yen for the first time in 24 years.

These decisions put a reverse spin on what's traditionally considered a currency war. Rather than trying to debase their currencies, policymakers are trying to engineer gains. There's a mounting sense that if central banks fail to keep pace with Fed tightening, their currencies will further weaken against the dollar, and ultimately drive up import costs and make the fight against inflation even harder.

"At a time of severe economic uncertainty, the dollar is being heavily backed in currency markets and others are suffering the consequences," Oanda analyst Craig Erlam told Insider.

Some strategists are already skeptical of efforts that have been taken so far, particularly around the actions taken by the BOJ.

"We are highly doubtful this will work in turning the yen trend," Deutsche Bank FX analyst George Saravelos said Friday. "The bottom line is that for the yen to start strengthening … the global dollar positive environment needs to turn."

The Bank of England's intervention on Monday was more minor, but — after raising interest rates 50 basis points last week — the central bank has said it "will not hesitate" to hike more aggressively at its next gathering in November.

The bank's latest statement came after the new UK government's tax-cutting proposals spooked markets and sent the pound plummeting to an all-time low against the dollar. 

While the UK central bank won't blindly prop up the pound, its partial intervention shows it is concerned about the impact sterling's devaluation will have on soaring prices, an analyst said. The UK imports most of its food and fuel from abroad, and the pound's slide will make those goods more expensive with inflation already running at 9.9%.

"Speculations [of an emergency meeting] were denied but at the same time the bank said that it will not hesitate to raise interest rates 'by as much as needed'," SEB strategist Jussi Hiljanen said. "The messages may appear to be a bit contradictory but should probably be interpreted as the bank committing to act strongly against inflation but not to strengthen the pound."

Japan and the UK aren't the only countries scrambling to keep up with the Fed.

The People's Bank of China moved to prop up its currency by fixing the onshore yuan at stronger-than-expected levels in August, while Sweden's Riksbank announced a supersized 100 basis point hike last week.

Elsewhere, the Swiss National Bank lifted its policy rate by 75 basis points, exiting the negative interest rates it had implemented in 2014 to stimulate the economy.

Between the 2008 financial crisis and this year, "no one was concerned about inflation, concerns centered on growth," ING's global head of markets Chris Turner told Insider.

"Fast forward to today and the concern is inflation," he added. "But most countries can't keep pace with the mighty dollar — or the mighty Fed."

Read more: The UK pound just tumbled to a record low against the dollar. That could drive up food and gas prices for already struggling households.

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