Thursday March 24, 2005 - 11:21:25 GMT
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INVESTICA Ltd - www.investica.co.uk
Where next for the dollar?
The dollar remained strong during Wednesday with the currency benefiting from inflation concerns and speculation over a more aggressive interest rate policy. The dollar pushed through 1.30 after the US inflation data, but struggled to hold the position stronger than 1.30, fluctuating close to this level in early Europe on Thursday.
The US consumer inflation report fuelled inflation concerns. Prices rose 0.4% in February compared with expectations of a 0.3% increase and the underlying rate was also higher than expected at 0.3%, pushing the core annual rate to the highest level since May 2002. Although energy costs were high, there were also significant increases for medical and transport costs. The report will heighten expectations that the Fed will tighten more aggressively and switch to a 0.5% increase in interest rates.
Although inflation fears will offer near-term dollar support, there is likely to be a growing debate as to the medium-term impact. There will be concerns that a sustained slide in bond and equity prices will damage the US ability to fund its current account deficit. These fears are at the very least likely to result in significant dollar setbacks at times.
Given expectations of higher US interest rates there will be the risk of a further closing in long positions in high-yield, emerging and commodity currencies. Any closing of positions will offer further near-term dollar support as they will have been funded through the dollar. There is likely to be scope for at least a limited short-term correction and a pause in selling pressure after the sharp moves over the past 48 hours.
There is still likely to be structural Euro buying below the 1.30 level with global central banks taking advantage of the weaker currency to boost Euro reserves and this will make it more difficult for the US currency to sustain further rallies.
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