IMF warns of global currency war risk

THE head of the International Monetary Fund has warned of the risks of a global currency war, as tensions over China's undervalued currency threaten to dominate this weekend's annual meeting of world finance ministers in Washington.

As Japan's central bank began intervening in currency markets to put a lid on the rising yen, the IMF again appealed to China and other emerging economies to allow the markets to set their exchange rates, rather than holding them down to gain a competitive edge.

The appeal came in the IMF's new World Economic Outlook, released overnight, which offers barely changed forecasts for growth in 2011: 4.2 per cent for the world, and 3.5 per cent for Australia.

IMF head Dominique Strauss-Kahn told The Financial Times that Japan's currency intervention made sense if its goal was "to avoid disruptive volatility", but not if it wished to influence the yen long-term.

With an understatement worthy of Casablanca, Mr Strauss-Kahn told the FT that "there is clearly the idea beginning to circulate that currencies can be used as a policy weapon.

"Translated into action, such an idea would represent a very serious risk to the world economy," he warned. "Any such approach would have a negative and very damaging longer-run impact."

China is widely seen as keeping its currency undervalued to make its exports more competitive, and hence attract more foreign investment. In the US, Congress is stepping up pressure on the Obama administration to formally declare China a currency manipulator, and take action against it.

In recent weeks, central banks in Japan, Korea and Taiwan have intervened on currency markets to stop their currencies rising. Brazil has doubled its tax on short-term capital inflows to 4 per cent. But Australia's Reserve Bank has allowed its dollar to keep rising. Last night it was trading at US97.20, up 1.5? in a day.

Markets expect it to overtake the US dollar in coming weeks for the first time since it was floated in 1983.

The IMF's latest 90-page set of forecasts virtually ignore Australia, other than to warn that it faces a "low-risk" threat of a housing crash.

For Australia, the main change is that the IMF has lifted its 2011 inflation forecast to 3 per cent but cut its forecast of the current account deficit. It predicts unemployment will be steady at 5.1 per cent.