For decades the United States led the push for lower tariffs worldwide, but US President Donald Trump is testing the solidarity of his G20 peers with a protectionist line on trade, putting central bankers in a tough spot with depleted resources to battle a downturn that may be coming sooner than expected.
The U.S.-China trade war is the elephant in the room at this week’s G20 summit of the world’s top economies, and major central banks may find themselves pressed into defensive action in short order should an expected face-to-face meeting between Trump and Chinese President Xi Jinping go badly.
The resulting race to the bottom in interest rates - and currency values - could rekindle the kind of acrimony among G20 officials so evident during the years of massive bond buying by the U.S. Federal Reserve after the financial crisis.
And the race may already be under way.
Under pressure from financial markets and wary of signs the global economy might be slowing, the Fed earlier this year called an effective halt to further rate increases, and at its meeting this month indicated rate cuts may be on the way.
While Fed officials on Thursday pushed back on market expectations for a significant, half a percentage point rate cut as soon as next month, the U.S. central bank is still seen lowering rates once or twice by the end of this year.
It is a shift that could make for tense talks at the G20 meetings, and force a discussion on how to fight the next recession before Europe and Japan end the extraordinary monetary steps taken to fight the previous one.
The impact of looser Fed policy may be felt around the world through a decline in the dollar, which could pressure Europe and Japan to follow suit to keep their exporters competitive - the makings of the tension over currency that has plagued G20 meetings before.
“It is hard to see how you get a cooperative outcome,” said Vincent Reinhart, chief economist at Standish Mellon Asset Management and a former top staffer at the Fed.
“A trade dispute can become a currency dispute pretty quickly. If what the United States ultimately wants is a depreciation, I don’t see others raising their hands and saying I will take the appreciation ... We don’t have many trading partners that are in a position to share weakness.” European and Japanese policymakers say they will abide by the G20 agreement to refrain from competitive currency devaluation, and use monetary tools only for domestic purposes.
With little firepower left, however, the ECB and the BOJ both have good reason to try and prevent a spike in their currencies from weighing on already soft exports and inflation.
Some ECB policymakers have already expressed concern in the June policy meeting that any easing from the Fed could drive the euro higher, supporting the case for more ECB easing.
“I’ll give you five reasons for a rate cut,” said a policymaker, who asked not to be identified, before repeating “exchange rate” five times.
Bank of Japan Governor Haruhiko Kuroda also signalled last week his readiness to ramp up stimulus if growth slumps, going so far as to say any step the central bank takes could take will seek maximum stimulus effect at minimum cost.
If Fed rate cuts trigger a spike in the euro, that could put pressure on the ECB to ramp up stimulus to counter the pain, analysts say. The ECB next meets for a rate review on July 25.
There is also increasing market speculation the BOJ, which applies a 0.1% negative short-term rate and a zero percent cap on long-term rates, will ease as early as its rate review on July 29-30 depending on the Fed’s moves.
“If the Fed cuts rates, the BOJ and the ECB must do something more powerful to contain currency appreciation,” said Sayuri Shirai, a former BOJ policymaker who is currently professor at Japan’s Keio University.
“They might be acting to achieve their domestic mandates. But the fact is such action would affect the global economy and yet, the G20 isn’t discussing this.”