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Benchmark Currencies Rally as the US Dollar Slides
By Kai Sandvig, Business Editor
Posted October 15, 2007

      

    The value of the US dollar continues to slide against other benchmark currencies, including a more valuable Canadian dollar.

    In currency spot trading early Monday, the euro rose to $1.4231 and the British pound rose to $2.0408. The euro has risen 2.6 percent since Sept. 18, when the Federal Open Markets Committee (FOMC) cut the US overnight lending rate from 5.25 percent to 4.75 percent. The Canadian dollar has risen to $1.028 after reaching parity with the greenback for the first time since 1976.

    The FOMC passively cited a poor US housing market alongside an explicit statement of lower inflation in its action of slashing 50 basis points, the first Fed cut since 2003 when Fed officials allowed a gradual rate increase to help thwart inflationary pressures on the US economy.

    Euro-zone economic policy makers have called for halt in the rise of the euro against the US dollar in recent days in order to maintain lower export costs from the Euro-zone. However, exports from the region have grown and the European Central Bank (ECB) may raise its rates, precipitating a further differential increase.

    Seeking further enlightenment on the subject from Moody's Corp. Senior Economist, Matthew Cairns, responded to a list of email questions for The European Weekly Online.

    “Broadly speaking, this is an interest rate differential story,” Cairns wrote. “As the Fed reached the peak in its cycle and then opted to cute on the back of weaker economic prospects, the euro continued to rise.”

    “The ECB may not be done hiking, thus offering investors the potential for additional yield,” Cairns wrote.

    “As the Fed opted to cut rates in order to stabilize markets, expectations and growth, the lower Fed Funds rate, used to stimulate the economy, has weakened the US currency by giving investors lower returns on their investments denominated in the US currency,” Cairns wrote.

    Many positive aspects of a less valuable US dollar have been widely noted, such as lower export prices, but US bound import prices have received little attention in economic dialog. The US imports durable goods and commodities such as automobiles and oil that are vulnerable to whimsical change in price, such as oil prices attaining an all-time high of around $85 per barrel for oil in Monday trading.

    “Should the prevailing interest rate and growth differentials hold over the coming months, the dollar's weakness will put upward pressure on import prices,” Cairns wrote.

    “Petroleum prices have dictated the magnitude and direction of import price growth over the past few months. This trend will persist as crude oil prices are currently trading at or near record highs. If these gains are sustained, high crude oil prices will put upward pressure on import prices in September,” Cairns wrote.

    The Euro-zone will also experience economic ramifications due to a stronger euro.

    “The stronger euro is likely to affect exports over time, but at present, the currency is helping Euro-zone firms buy raw commodities and other inputs on international markets at a cheaper rate,” Cairns wrote.

    In light of the sliding US dollar, Cairns believes the currency will maintain its importance as a benchmark currency.

    “The dollar has been subject to sharp swings in fortune for many years. This is not the first time the dollar has been hit and given the size of the US economy, the strength of its consumer base and success of its firms, the dollar's 'value' as a benchmark currency will not be harmed,” Cairns wrote.

Kai Sandvig can be reached at kaisandvig@europeanweekly.net

 

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