08:24 AM EDT, 04/26/2024 (MT Newswires) -- The US dollar's rally this year is unlikely to trouble the global economy and it would likely take a further 5% increase or more for it to materially impact the outlook for growth around the rest of the world, according to Capital Economics.

Dollars have been bought widely in recent months, leading to gains over all currencies in the G20 basket for the year-to-date and prompting some to wonder whether it might be imposing an additional burden on the global economy.

"The US dollar would have to appreciate a lot further before having significant effects on the global economy and financial system," said Jonas Goltermann, deputy chief markets economist at Capital Economics. "A key risk to watch for is the widening policy divergence between the US and Asia leading to a major depreciation in the renminbi."

There are four primary channels through which a strong strong dollar impacts the global economy and financial system, Goltermann wrote in a Thursday note to clients.

First, it leads to higher import prices and increased inflation in small and open economies. Second, it hurts demand by reducing purchasing power in the rest of the world. Third, it undermines financial stability by making dollar-based financing more expensive. Fourth, it puts pressure on exchange rates that are pegged to the dollar, and particularly those of countries that are also attempting to exercise an independent monetary policy instead of simply mimicking Federal Reserve policy.

"As things stand, we think the impact on the global economy through these channels will remain limited," Goltermann said.

So far the dollar's rally has been small in the historical context: The ICE Dollar Index had risen by around 5% in the year-to-date on Friday while the Fed's Broad U.S. Dollar Index had climbed by a lesser 3.2% by April 19. However, previously, the ICE Dollar Index rose by 25% between May 2021 and October 2022. And it appreciated by 10% in the four months between May and September 2022, while the Fed's Broad Dollar Index rose 8.2% over the same four month window.

What's more, the latest dollar rally has not been accompanied by a material tightening of credit conditions or any meaningful deterioration of risk appetite. This is another reason why its impact on the global economy will remain limited, according to Goltermann, and particularly if Capital Economics is right in forecasting that the dollar is close to having topped out.

"The key risk, in our view, lies with China's de facto policy of preventing renminbi depreciation against the dollar," Goltermann said. "As US yields have picked up over recent weeks, the strains on the USD/CNY rate appear to have increased."

The risk to all of this and the largest source of upside potential for the dollar comes in a scenario where Chinese policymakers conclude that any benefit gained by keeping the USD/CNY rate pinned down is no longer worth the cost of doing so.

USD/CNY has persistently traded at or around the maximum level allowable under the managed-floating exchange rate regime operated by the Peoples' Bank of China in recent months, suggesting capital outflows and frequent intervention by authorities.

"China's decision makers may conclude that the costs of preventing renminbi depreciation outweigh the benefits, and allow the USD/CNY rate to weaken more substantially," Goltermann said. "As in 2015-16 and 2018-19, that could well lead to depreciation pressure on other currencies, increased volatility and a general worsening of risk appetite across markets."