US Economic Slowdown, Rate Cuts to Drub Dollar

By Platt, Gordon | Global Finance, February 2008 | Go to article overview

US Economic Slowdown, Rate Cuts to Drub Dollar


Platt, Gordon, Global Finance


With the US economy nearing a recession, if it hasn't already entered one, the Federal Reserve will continue cutting interest rates in the months ahead, likely leading to further losses in the already beat-up dollar, analysts say.

The dollar should fall against most major currencies in the first half of 2008, as the United States leads the global slowdown and the Fed eases, says Gabriel de Kock, Citi's chief currency economist in New York. "But the global credit crisis poses hurdles for economic activity in many countries outside the US, creating scope for a dollar recovery in the second half of 2008," he adds.

The euro, which gained about 12% against the dollar in 2007, is expected to appreciate further in the first half of this year but to lose ground later in the year, when the European Central Bank is expected to respond to tighter financial conditions, the Citi economist says.

The bank's forecast for continued growth in emerging markets points to faster currency adjustment in many developing countries, but this depends critically on further monetary policy easing from the major industrialized economies to lessen risks of a global slowdown, de Kock says. There are closer economic ties between emerging markets and industrialized countries than ever before, he notes.

De Kock notes that "2007 will be remembered for the severe credit crunch triggered by the subprime meltdown, the sharp second-half spike in market volatility from historic lows and for the steepest broad dollar decline since 2003." He adds: "We expect the dollar to overshoot to the downside against most Group of 10 currencies in the first half of 2008, as the US economy and markets weaken further."

Outside the US, the impact of the liquidity and credit crunch appears most acute in the United Kingdom, where further monetary policy easing is expected to counter a sharp housing correction, consumer retrenchment and slower corporate expansion, de Kock says. The British pound has been the weakest major currency against the dollar in recent months, dropping from $2.11 early last November to an eightmonth low of $1.95 in midJanuary and to a record low against the euro.

"We may as well name the pound as the 'dollar of 2008,' as it faces ample downside room," says Ashraf Laidi, chief foreign exchange analyst at CMC Markets US in New York. "We expect more losses for the pound, as the Bank of England is seen cutting rates throughout this year," he says. Weakness in the pound will be a major theme in currencies for 2008, which should help the dollar to obtain some stability, he predicts.

The Bank of England lowered interest rates to 5.5% in December 2007, its first cut since August 2005. While the UK central bank stood pat on rates in January, Barclays Capital economists expect another cut this month. "We think there is a risk the Bank of England may cut rates faster than is currently priced into the markets," says Paul Robinson, chief sterling strategist at Barclays Capital in London. There is a downbeat mood surrounding the UK economy, and if consumers and businesses become more pessimistic about prospects, the economy is almost certain to slow because spending will likely slow, he adds. …

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