Europe and US unite on stronger dollar

Europe and US unite on stronger dollar

By Krishna Guha in Washington and Ralph Atkins in Frankfurt

Published: May 8 2008 02:01 | Last updated: May 8 2008 02:01

The US and Europe now have a united desire to see the dollar strengthen against the euro, senior officials have told the Financial Times.

Policymakers welcome the recent rebound in the dollar, which at one point on Wednesday rallied to a six-week high against the euro. They are concerned that the currency markets have been paying too much attention to short-term economic weakness and market stress in the US, and not enough to the medium-term prospects for the US and Europe, a senior US official said.

Senior eurozone officials believe that the dollar-euro rate had reached levels unhelpful to both the US and Europe.

Policymakers on both sides of the Atlantic want to avoid a situation in which the dollar falls too far, before snapping back as investors realise the US is not heading for a depression and Europe’s economy is starting to soften, too. Such abrupt currency movements could fuel instability in financial markets.

Top officials also want to avoid dollar weakness reinforcing the rise in oil prices. They do not think the dollar is the main cause of the rise – oil has gained on days when the dollar has strengthened. But they agree that dollar weakness has at times contributed to oil’s strength.

François Fillon, French prime minister, told reporters last week in Washington: “We believe that the euro globally speaking is overvalued...the US authorities are repeating ad nauseam that the dollar is too weak.” Jean-Claude Trichet, president of the European Central Bank, has long stressed US interest in a strong dollar.

Officials highlight the importance of the April G7 communiqué, which expressed “concern” about “sharp fluctuations in major currencies”. Many analysts still reckon the US has a policy of benign neglect towards the dollar – welcoming the boost from dollar weakness to exports.

However, both US and European officials intended the communiqué to signal that they did not want the dollar to weaken and, in the context of a likely US recovery, feel it had reached the stage where it was oversold.

“The short-term was getting more attention than the long term,” the senior US official said.

The US is still a long way from agreeing to intervene in currency markets or identifying desired exchange rates. But both sides believe fundamentals and central bank policies are turning in the direction of relative dollar strength. After cutting interest rates aggressively, the Federal Reserve has indicated its desire to pause. Meanwhile, the ECB is softening its hawkish tone, and could shift further if weaker growth reduced inflation risk.

The central banks have not ­co-ordinated their policies to manage the exchange rate. But policymakers feel communicating the change in relative fundamentals and monetary policies may be effective.

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The Short View: Euro and oil

By John Authers, Investment Editor

Published: May 7 2008 21:02 | Last updated: May 7 2008 21:02

Over the last year, foreign exchange traders have had an easy way to check up on oil prices. They simply look at how the euro is performing against the dollar. If the euro is gaining, then the crude price is rising.

That is what has happened most of the time. Crude has shot to a record while the euro has reached highs against the dollar – and the many macro hedge fund managers who have made this bet have done very well. But the last week suggests that relationship is weakening.

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John Authers

John Authers on euro and crude oil

So far this month, crude prices have gained 8 per cent, to an all-time record, while the euro has dropped 1.7 per cent. It has now depreciated by more than 4 per cent since briefly exceeding $1.60 on April 22.

This appears to do some damage to the popular thesis that the rise of the oil price, which is quoted in dollars, was merely the logical consequence of the fall in the dollar.

Why has this happened? There have been worries about supply disruptions for oil, centred on Nigeria. Meanwhile, confidence that the US economy will survive the downturn relatively unscathed has supported the dollar, as there is (questionable) confidence that US interest rates have reached a bottom. This confidence has pushed up crude.

Why has the euro fallen? European economic confidence surveys and consumer spending data suggest that businesses in the eurozone are now very worried about the prospect of a recession. That strengthens the belief that the European Central Bank, which meets today, will abandon its hawkish stance on interest rates and start cutting.

But this belief, in turn, looks overdone. There is a risk that the ECB will pour water on it. Headline eurozone inflation is now 3.6 per cent, its highest since the euro began. Oil prices put pressure on this to rise further. That in turn suggests that while the link between oil and the euro may weaken, it is not about to disappear.