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Fed Announcement Reignites Talk of Currency War

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"We are on the verge..."

[Editor’s note: the following is a crosspost by Katie Holliday that originally appeared on CNBC.com]:

The Federal Reserve's shocking decision not to taper, despite broad expectations for a $10-20 billion reduction of its monthly asset purchases, has reignited talk of a global currency war.

Risk-on currencies like the Australian dollar, the euro and the British pound soared in response, while the greenback dropped across the board. Now some analysts say the Fed's decision could prompt other central banks to devalue their currencies in an attempt to retain a competitive edge.

"We are on the verge [of a currency war]... especially if the Fed does not taper in October or December..." said Boris Schlossberg, MD of BK Asset Management.

Federal Reserve Chairman Ben Bernanke arrives to speak at a news conference at the Federal Reserve, Sept. 18, 2013 in Washington, DC. Chairman Bernanke spoke after a closed door meeting of the Federal Open Market Committee. The Federal Reserve announced that it will not scale back the bond-buying program and continue buying bonds at $85 billion a month (Credit: Getty Images)

The other G10 countries will have to react and the only thing they can do is provide "even more accommodative policies in order to try and equalize all these currency differentials," he added.

Speculation over the onset of a global currency war first came to a head at the start of the year when dramatic falls in the Japanese yen prompted widespread criticism from other world economies, amid concerns the yen's weakness would put Japan's exporters at an unfair advantage. However, the rhetoric abated after Japan was given the go-ahead to pursue its radical policies at a G20 meeting in April.

But the Fed's decision on Thursday has reignited talk of a currency war, after the dollar index, which measures the greenback's value against other major currencies slid to levels not seen since February at 80.06 on Wednesday.

Risk-on currencies got a boost; the Australian dollar rallied above the $0.95 handle in Asia on Thursday, a high not seen since mid-June, while the sterling surged to around $1.61, its highest level since January, and the euro reached highs not seen since February of around $1.35.

Evan Lucas, market strategist at IG, said he expected other major central banks to react.

"All major pairs with the U.S. dollar are running hot, with AUD/USD the strongest performer up 1.8% in the U.S. session and EUR/USD not far behind. This does raise the question, what will be the responses from other central banks?" he said.

Lucas pointed to the Reserve Bank of Australia, which is broadly expected to cut interest rates again by year end, as one of the next likely movers.

"It also raises questions about the Bank of Japan," said Lucas. "The fall in the USD is dire to its stimulus plans for the yen and the broader Japanese economy. Will the Bank have to intervene again? Will the three arrows be ramped up?"

BK Asset Management's Schlossberg said he expected Japan's central bank to act soon.

The dollar-yen isn't buckling as much as other currencies; that's a sign that the market expects the Bank of Japan to be the first to try to offset the Fed's move with a move of its own, he said.

International Monetary Fund managing director Christine Lagarde, right, talks with chairman of the Eurogroup and Dutch Finance Minister Jeroen Dijsselbloem, during the Eurogroup meeting, at the European Council building in Brussels, Monday, Feb. 11, 2013 (AP)

The yen strengthened to 97.75 to the dollar following the Fed announcement on Wednesday, but had weakened back to around 98.10 to the dollar in early Asian trade on Thursday.

Schlossberg also highlighted the Bank of England as another central bank likely to respond to the Fed's move.

"Someone wrote a very clever line today saying that the BOE didn't realize it was in a quantitative easing war and now it's going to have to [head] back into battle," he said.

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