Where next for currencies?

August 14, 2001 Posted: 1011 GMT

LONDON (CNN) -- U.S. and Japanese travelers may be disappointed. German ones may get a nice surprise.

It's all because of the latest turbulence in the foreign exchange markets – currencies are in motion at the height of the summer holiday season.

The euro has gained some 6 percent against the dollar in the past five weeks, while the yen has lost ground against both the dollar and the euro.

Continuing poor numbers from the U.S. economy and a slowdown in portfolio flows into the U.S. are taking their toll on the greenback.

"Portfolio flows had been the main driving force behind dollar strength," said Ian Stannard of BNP Paribas. "During the summer months we see a slowdown in financial market activity, and this reduces the flows into the U.S. and hence reduces support for the dollar."

	If we see a weakening economy and a weakening currency, that poses all sorts of problems for the (U.S.) administration and the Fed.
	Peter Dixon Commerzbank

In the latest sign of slowdown in the economy, a Labor Department report last Friday showed that U.S. wholesale prices fell again in July, posting their biggest decline in eight years.

The producer price index fell 0.9 percent last month, dropping far more steeply than experts predicted. Wall Street economists surveyed by Briefing.com had forecast the PPI would fall 0.3 percent.          

The recent weakness of the U.S. currency, if maintained, could prove a bonus for U.S. exporters. They'll recover some of the competitive edge that European rivals have enjoyed in the past year.

But analysts say the U.S. government is not about to change its strong-dollar policy, regardless of the U.S. economic slowdown.

"I think the reason that the U.S. would not want to be seen to be backing off from the strong-dollar policy is that it gives the markets the license to sell the dollar," said Peter Dixon of Commerzbank. "And I think that obviously if we see a weakening economy and a weakening currency, that poses all sorts of problems for the administration and for the Fed."

Interest-rate outlook

Indeed, a week dollar could have the effect of boosting inflation and discouraging further interest-rate cuts.

The U.S. economy has been in a slowdown for about a year, with businesses curtailing spending and cutting hundreds of thousands of jobs. In order to keep consumers spending and avoid a recession, the Federal Reserve has slashed its target for short-term interest rates six times this year, from 6.5 percent to 3.75 percent.

The U.S. Federal Reserve is expected to cut rates as early as next week. That could prove a lift for the dollar, but if the European Central Bank cuts euro-zone rates at the end of August the currency impact may he evened out.

Economists predict that the ECB will cut rates for the second time this year when it meets after its summer break on August 30.

Earlier this month the ECB, as expected, kept its official rate at 4.5 percent, signalling that the battle against inflation took priority over warding off the threat of economic slowdown.

"The ECB will come through with a cut, but it will wait to see what happens on the inflation front," said Ben Rudd, a market strategist at HSBC. "They'll wait until this year's energy price increases come out of the (inflation) number, giving them leeway to cut rates."

Tom Bogdanowicz contributed to this report.

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