Slower U.S. economic growth to take toll on greenback
Slower U.S. economic growth to take toll on greenback
LONDON (Reuters): Slower growth in the U.S. and recovering
European economies will take the steam out of a two-year uptrend
in the dollar next year, currency analysts say.
The weakness of the Japanese economy and the negative impact
of Southeast Asian currency devaluations will allow the dollar to
notch up more gains against the yen. However, in the second half
analysts expect the yen to recover as Japan comes out of the
doldrums.
Expectations that the German economic recovery will gather
momentum, meanwhile, will prop up the mark.
"Overall, it will be a year of recovering economies in Europe
and Japan and slower growth in the U.S., which is a reversal of
the dynamics that we have seen in the past two years," said Don
Smith, international economist at HSBC Markets.
Over much of the past two years the dollar benefited from U.S.
and German interest rate differentials moving heavily in favor of
the U.S. as the economy there enjoyed strong growth and low
inflation.
Last summer that process started to reverse as markets
reassessed their views about economic recovery in Europe, and in
Germany in particular.
Many forecasters predict the dollar has already peaked after
hitting highs just below 1.90 marks this year. A Reuters December
FX poll predicts a decline to 1.7000 towards the end of 1998 on
average, with the most bearish forecast at 1.5700 and the most
bullish at 1.94.
Some have stuck their necks out with forecasts for a yen
decline as low as 145. The average forecast in the Reuters poll
is 121 by year-end, with 105 the highest yen forecast.
Yen weakness is expected to be limited to 135 yen by many
traders, due to fear of central bank intervention as policy
makers want to avoid excessive yen weakness. A further gradual
weakening is unlikely to meet much official resistance since a
stronger yen would deal a savage blow to Japanese recovery
attempts.
"The authorities (would) rather have an export-led recovery in
Japan than no recovery at all," said Chris Furness, senior market
strategist at 4CAST.
On Dec. 17, the Bank of Japan put steel into its efforts to
stem excessive yen weakness by selling dollars for yen for the
first time since 1992. The intervention came after Japan
announced a surprise cut in personal income taxes in a bid to
spur economic recovery.
Exports
In the U.S., growth will be tempered by the negative impact of
the strong dollar on exports. It typically takes about two years
for the full impact of currency strength to be felt.
Since 1995, the dollar has risen from a record low of 1.3430
marks to a near-eight year high of 1.8913 at the end of October
and from 79.70 yen in April 1995 to a 5-1/2 year high at 130.81
this December.
U.S. growth is expected to slow from a fiery expected rate of
3.8 percent to around 2.5 percent in 1998.
The recovery process in Europe might be slow as widescale
continues to weigh on domestic demand, in particular in Germany
and France.
But in the developed world, Europe is the region least
affected by financial turmoil in Asia, and this expected to
benefit the mark and European currencies linked to it.
About 9 percent of exports from the European Union go to Asia,
according to OECD data. The U.S. has a much larger share with
some 30 percent to the region.
However, part of the negative impact on growth is likely to be
offset by strong U.S. domestic demand, and on the positive side,
it might reduce inflationary pressures.
"The European economies are the least affected by the fall-out
from Asia," said Keith Edmonds, chief analyst at IBJ
International. "As a result we expect the mark to be bid, in
particular if the Bundesbank decides to nudge up rates again."
The latest Merrill Lynch quarterly global investor survey
supports the positive mark view. It showed funds raised their
exposure to overweight in November from underweight in the
previous quarter.
The global rate outlook depends heavily on whether the
situation in Asia stabilizes and also -- in the U.S -- whether
jobs growth slows down, analysts said.
A tight labor market means the Federal Reserve keeps a close
watch for signs of emerging price pressures.
The Fed has kept rates on hold since March, when it raised the
key federal funds rate by a quarter point to 5.5 percent. The
Bundesbank raised its repo rate to 3.30 percent from 3.00 percent
in October.
One of the event risks on the list is the repatriation of
funds by Japanese investors towards the end of the first quarter
when their fiscal year ends, which typically boosts the yen.
German election
The key political event will be the German federal election in
September 1998. So far it has failed to excite forex traders even
though support for veteran Chancellor Helmut Kohl is waning.
Analysts don't expect significant changes to economic policy if
the opposition Social Democrats (SDP) wins.
In recent polls the SDP have sometimes been neck and neck and
sometimes slightly ahead of the Christian Democrats (CDU).
In regional German state elections, Lower Saxony will be first
off the mark in March. Since their Premier Gerhard Schroeder is
tipped to run against Kohl next year the pundits will be out in
force.
Schroeder has called for a delay to European economic and
monetary union (EMU), but the SPD does not seem to want to make
the euro a campaign issue.
A timely and broad start to European economic and monetary
union (EMU) with 11 founding members is almost a done deal for
the markets.
The assumption that a broad EMU automatically means a soft
euro is already being reassessed, analysts said.
Inflation in the euro-zone will be monitored with eagle eyes
by the independent European Central Bank, while its fiscal policy
will be constrained by the stability pact.
Also, Europe runs a significant current account surplus, while
the U.S. runs a deficit that is expected to widen in 1998.
The growing gap is a result of strong U.S. demand and the
combined effect of weaker domestic demand in Asia and Latin
America and greater competitiveness in Asia due to the
devaluations of many currencies in the region.