Ahead of the meeting, the Europeans are fretting over the impact of a strong euro on the region’s exporters, while the dollar’s slide is making a mockery of the US Treasury’s mantra that a strong currency is in the country’s interests. In Tokyo, the yen’s slide rings alarm bells as investors show a new interest in carry trades, in which the low-yielding Japanese currency is sold to finance purchase of riskier assets elsewhere.
Meanwhile, China continues to decline persistent invitations from the US and Europe to let the renminbi appreciate faster.
The year has already seen dramatic moves in the FX market. The dollar has fallen over 7 per cent against the euro and is flirting with its record low around $1.4280. The single currency stands just Y5 below its record peak of Y168.80 against the yen in July.
French politicians have been the most vocal over the rise of the euro, with Christine Lagarde, France’s finance minister, making repeated references in recent weeks to the damage being done to eurozone exporters.
In this context, Mansoor Mohi-uddin at UBS believes the G7 meeting will be one of the most important of the past few years. He says that while the Fed cut interest rates by more than expected last month, the accompanying statement warned about the risks from inflation.
“Clearly a much weaker dollar from here would make life more difficult for the Fed,” says Mr Mohi-uddin.
“With America’s bond curve steepening and commodity prices staying high, sustained exchange rate weakness would help revive inflationary expectations at a time when the Fed is easing monetary policy.”
He says that if the dollar continues to slide, the G7 can warn markets that its members stand ready to act.
“The last intervention by G7 members in September 2000 put a long-term floor under the single currency. So any warning about the risk of intervention should be heeded by market participants now.”
Mr Mohi-uddin says he remains sceptical about the consensus that the dollar will continue to fall against the euro.
“In the longer term, the euro will not be able to sustain its current levels against the dollar if the US economy doesn’t fall into recession,” he says.
“In the near term, any further overshooting of the dollar is likely to spur a reaction from the G7.”
However, analysts say that although the US pays lip-service to a strong dollar policy, it is unlikely to agree to any specific reference to dollar weakness in the widely scrutinised statement released after this weekend’s meeting.
Simon Derrick at Bank of New York Mellon says all the signs indicate that the US Treasury remains comfortable with its currency policy, while Ben Bernanke, Fed chairman, continues to sound dovish on interest rates.
“It seems likely that the dollar-negative forces emerging since mid-August will build in intensity,” he says.
“As long as this does not lead to a full-scale rout in US asset markets, it is arguable that US officials may even be quite happy with this outcome if it brings further pressure to bear upon those nations that currently peg their currencies or run dirty floats against the dollar.”
Mr Derrick says it seems clear that Jean-Claude Trichet, European Central Bank governor, has convinced European politicians that their best chance of getting a reference to currency misalignment in the post-G7 statement is to join forces with the US in condemning Japanese and Chinese policy.
“The Europeans have decided to line up alongside the US to make a more forthright statement over the value of the yen and the renminbi,” he says.
Comments from Christine Lagarde on Monday seemed to reflect that change of tack.
She said that the levels of the yen and the renminbi did not reflect the dynamism of the Japanese and Chinese economies.
“We must not focus uniquely on the level of the euro against the dollar, but consider also its level against the yen and the renminbi,” she said.
Mr Derrick believes Tuesday’s sharp appreciation in the yen was triggered by the market’s realisation that the currency’s weakness could be addressed by the G7.
“It seems like the starting pistol has been fired,” he says. “The currency markets have the potential to be quite lively over the next few days.”
However, Marc Chandler at Brown Brothers Harriman says those who believe this G7 meeting might be one of the most important in years are likely to be disappointed.
“While G7 officials have no doubt been in communication about market developments, if there was going to be a co-ordinated response, surely we would have seen it by now,” he says.
Mr Chandler says the dollar’s decline has been orderly and fundamentally comprehensible, given the trajectory of interest rate differentials.
Meanwhile, he says, the euro’s rise has not yet crossed the ECB’s pain threshold, with some council members continuing to highlight the benefits of a strong euro in offsetting the rise in oil prices.
“Those observers that detect an intensification of official concerns about the strength of the euro mistakenly confuse the rhetoric of stakeholders, like finance minister Lagarde and some exporters, with decision-making ECB board members,” he says.
