Central banks support weak dollar
By Jennifer Hughes
Published: May 9 2003 9:05 | Last Updated: May 9 2003 17:06
Support for the weak dollar appeared to come this week from leading central bankers who scared the currency markets by implying that the risks of deflation were rising. The currency markets marked the dollar down sharply to reach a fresh four-year low against the euro although central banks left interest rates unchanged.
Alex Schuman, senior currency strategist at Commonwealth Bank of Australia, even likened the current situation to the Plaza Accord of 1985, when an agreement by central banks to co-ordinate dollar easing saw the greenback nearly halve in value over the following two years.
Alan Greenspan, chairman of the US Federal Reserve, referred to the "minor" probability of "an unwelcome substantial fall in inflation." The statement was the first by the bank to refer to the risks of low inflation and strategists said the comments implied tacit approval by the Fed for a weaker dollar and the accompanying inflationary effects.
John Snow, US Treasury secretary, also appeared to signal official support for a weaker dollar. Mr Snow maintained the Bush administration favoured a strong dollar, but added the way to achieve that was to work on the fundamentals of the US economy. The comments contrasted with those of Robert Rubin, the former US Treasury secretary, who first developed the "strong dollar" policy, believing it to be beneficial for the US economy.
"The clear indication [from Mr Snow's comments] is that, in current circumstances where the US economy is weak, the dollar should also be weak," CBA's Mr Schuman said.
The dollar slipped across the board on Tuesday, only to recover slightly on Wednesday as investors turned their attention to the meetings of the European Central Bank and the Bank of England. A substantial minority of analysts believed both banks would ease policy.
The euro rallied after the ECB announced interest rates would remain unchanged at 2.5 per cent on Thursday. The single currency leapt higher still after Wim Duisenberg, ECB head, shrugged aside concerns about the euro's rise, saying the currency's levels were well within most estimates of its fair value.
The euro gained 2.9 per cent this week to reach a high of $1.1537 against the dollar and stood 9 per cent higher on the year to date.
"The ECB's stance means buying the euro is like pushing an open door," said Mark Cliffe, chief economist at ING Financial Markets, who noted many strategists are likely to see the euro hit their year-end targets by the end of this month. ING has a target of $1.15 "but we expect it to go higher then retrace," added Mr Cliffe.
Sterling's recent weakness was arguably a major factor in the Bank of England's decision to hold interest rates steady at its meeting. But the bank's decision proved no defence against the euro's march and the pound tumbled to further lows, down nearly 3 per cent on the week and its weakest since the single currency was introduced in 1999.
"For a while there have been a number of possible triggers for sterling weakness and these seem to be looming closer," said David Bloom, currencies strategist at HSBC. "The four pillars that made the UK relatively attractive - strong domestic growth, high levels of interest rates, transparent monetary policy and the prudent fiscal policy framework - are factors that are threatening to come undone."
Despite the bank's decision to hold rates steady, the market is still pricing in a 50 per cent probability of a further quarter-point cut in June. In the current bond-focused market, lower yields would weigh on the attractiveness of sterling assets.
Lower yields were not a problem for the Australian dollar after the Reserve Bank of Australia kept rates on hold and issued a relatively hawkish policy statement on Friday.
Investors had expected a fairly soft statement following weaker data, but strategists said the bank's tone suggested the next move in rates may well be up, not down.
The currency rallied to fresh three-year highs at US$0.6469 against the dollar, up 2.6 per cent this week and more than 13 per cent on the year to date.
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