Dollar will rise against weak euro and pound

published 15 August 2008

"Sentiment has turned 180 degrees," says Commerzbank's Ulrich Leuchtmann of the recent surge in the US currency. Last week the dollar index, which measures its value against a basket of currencies, put in its best performance in more than three and a half years. On Friday alone the greenback recorded its strongest 24-hour rise against the euro since 1999 and had climbed to a six-month high by the start of this week. Meanwhile, the pound tumbled to a 21-month low, close to $1.90. It seems that "following almost six years of straight decline, the greenback is making a vigorous beginning to what may prove a jittery recovery", commented Ian Campbell on Breakingviews.

What's behind the rise? "Talk and numbers," says Campbell. Part of the dollar's turnaround is down to a change of tone from Federal Reserve chairman Ben Bernanke. Having slashed the federal funds interest rate by a total of 3.25% over seven meetings between September 2007 and April this year, the rate has since been held at 2%. However, his recent comment that US inflation is "too high" consumer prices jumped 1.1% in June, the second-highest rise since 1982 raises the prospect of a US rate hike. Then there was encouraging American manufacturing data suggesting the economy may not be in freefall. As Rosemary Righter put it in The Times, "the PMI (Purchasing Managers Index) has held remarkably steady the sector is adding jobs and export orders are healthy". A falling oil price down around 20% from its July peak should also ease input costs.

The eurozone, until recently a beacon of strength, is now "heading into a recession from which it will struggle to recover" amid a "torrent of appalling data". Last month's eurozone PMI came in at 47.8 below 50 is considered a contraction the lowest reading since November 2001. Meanwhile, the confidence indicator fell at a faster rate than anytime since September 2001, dropping from 94.8 to 89.5 between June and July. While several eurozone countries are known to be in trouble, such as Italy and Spain, it is previously rock-solid Germany that has caused most of the latest concerns for the European Central Bank (ECB). Monthly retail sales, in a market that accounts for 28% of the eurozone, were down more than 1%. As Peter Garnham says in the FT, the data "quashes expectations of higher interest rates... the euro's recent joyride is over".

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The outlook for sterling, which hit a 26-year high above $2.10 last spring, is also grim. On Monday, a survey of 1,000 business leaders showed that a third expect redundancies at their firms; the CEO of the FSA recently warned the financial services industry to prepare for a downturn similar to the early 1990s recession. So while CPI (consumer price inflation) is well above the 2% target at 4.4%, "the Bank of England will feel happier cutting rates sooner rather than later" to try to protect growth, says Paul Robson at RBS. As BNP Paribas analyst Alan Clarke notes, swap rates already suggest a 50 basis point cut by the middle of 2009. With the recent gloom that has enveloped the dollar now shifting to the euro and sterling, "the dollar is in a genuine recovery", says Stephen Jen of Morgan Stanley. Its rise against both currencies "could run much further".