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.