Saturday November 27, 2004 - 11:05:07 GMT
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INVESTICA Ltd - www.investica.co.uk
Dollar under threat
Dollar sentiment will remain very weak in the short term with further concerns over the US current account deficit and potential financing difficulties. Events over the past week will increase fears over a diversification of global reserves away from the US currency, especially after the comments from Russia, although the actual data still suggests that capital is still flowing into the dollar. Given the reduced level of long-term inflows it is certainly the case that the dollar's underlying fundamentals have deteriorated. There will also be further speculation that the global central banks will tolerate or even encourage further dollar depreciation to help curb the US trade deficit. The central banks will, however, need to avoid disorderly markets and they will want to slow the dollar's decline.
The dollar has remained under pressure throughout the week and fell to a succession of fresh lows. The dollar weakened to 1.3335 in early Europe on Friday before partial corrective recovery to 1.3185, but it weakened back towards 1.33 in New York as underlying selling pressure continued.
There have been increased concerns over the US current account, increased funding requirements and the level of capital inflows. There have been persistent reports of central bank dollar selling over the week and this potential selling will remain a major medium-term concern for the US currency. With the US running a current account deficit of close to 6.0% of GDP, the US remains dependent on capital inflows to fund the deficit. If there is a decline in central bank buying and dollar recycling the US currency will be much more vulnerable to downward pressure and this would invite the possibility of very sharp dollar losses.
There will also be persistent concerns that the G7 countries have informally agreed to tolerate or even encourage the dollar decline. These concerns have been increased by Greenspanís comments last weak and apparent acceptance of a weaker dollar by the global authorities this week. The banks will, however, want to maintain orderly markets and there is an increasing risk of at least limited intervention to stabilise the US currency even if there is a tolerance of longer-term depreciation.
European comments over the Euro have been mixed during the week. The German IFO head openly called for the ECB to intervene to restrain the Euro while central bank officials also expressed concern over the currency gains. There will be increasing pressure on the ECB to intervene and there is an increased potential for covert intervention even if this is just to slow the rate of dollar decline. At this stage an interest rate cut look unlikely.
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