G-7 may have to do more than talk to stop dollar's slide

By Simon Kennedy
Bloomberg News Service
Monday, April 14,2008

http://www.bloomberg.com/apps/news?pid=20601087&sid=aRlmeTO1Ceag&refer=home

Group of Seven officials, signaling concern over a sliding dollar for the first time in 13 years, may have to match talk with action before the currency stages a sustained rebound.

U.S. Treasury Secretary Henry Paulson, European Central Bank President Jean-Claude Trichet and G-7 counterparts warned after talks in Washington on April 11 that recent "sharp fluctuations" in exchange rates risk hurting the global economy.

Sounding the alarm over the weakest dollar since the 1970s may still fail to buoy it so long as the ECB refuses to follow the Federal Reserve in cutting interest rates. Wariness of backing rhetoric with intervention may also limit the new language's effectiveness.

"Officials are clearly more concerned about the dollar, but are not yet ready to openly threaten the market because they know they would not be credible with the ECB's reluctance to lower interest rates," said Stephen Jen, head of currency research at Morgan Stanley in London.

The dollar rose to $1.5722 per euro at 12:08 p.m. in Tokyo, from $1.5808 late in New York on April 11. It earlier reached $1.56 a euro, the strongest level since April 3. The currency strengthened to 101.15 yen from 100.95.

The G-7 shifted its stance after the dollar's decline accelerated since the group met in February, slumping 8 percent to a record low against the euro and 6 percent versus the yen. Volatility on options for the dollar rose to 14.5 percent last month, the same as when the group last tried to prop up the U.S. currency in 1995.

The change represented a victory for European governments increasingly concerned that the dollar's slide threatens their exports. "I hope this concerted wording on currencies will help," French Finance Minister Christine Lagarde said in an interview with Bloomberg Television.

Paulson may have acquiesced in part because the lower dollar is pushing up the price of oil, and could pose a danger to foreign investment in U.S. stocks and other assets, said Jim O'Neill, chief economist at Goldman Sachs Group Inc. in London.

The surge in energy costs is exacerbating the U.S. economic deterioration by reducing the amount households have to spend on other goods and services. Record gasoline prices contributed to a slide in American consumer confidence to the lowest level since 1982 this month, a report showed last week. Higher fuel prices are also fanning U.S. inflation.

With Europeans clamoring for a message on the dollar, Paulson, who has a stated preference for letting markets set exchange rates, may have realized he had more power to influence the statement now than at the next meeting in June, said a former U.S. official. The official, who helped draft G-7 statements, noted that Japan chairs the next gathering of finance ministers in June.

The new language was the most significant change to the G- 7's stance on exchange rates since a meeting in Boca Raton, Florida, in February 2004, when it cautioned against "excess volatility." The last time it urged a stronger dollar was in October 1995. The group hasn't intervened to buy or sell currencies since purchasing euros in September 2000.

The G-7, which comprises the U.S., U.K., Canada, Japan, Germany, France, and Italy, also said the world economic slowdown may worsen amid an "entrenched" credit squeeze.

"The market is still adjusting; the turmoil has not yet settled down," Fed Vice Chairman Donald Kohn told reporters. "It's still a fragile situation out there."

Policy makers laid out a 100-day plan to strengthen regulation of capital markets. They urged financial companies to "fully" disclose their investments at risk of loss and boost capital as needed. They chose not to outline new monetary or fiscal policies other than promising action "as appropriate."

While the G-7's currency warning may help temper the dollar's descent, central banks would have to realign their monetary policies to reverse its direction, analysts said.

Since August, the Fed has lowered its main rate 3 percentage points to 2.25 percent, aiming to forestall a recession. At the same time, the ECB has kept its benchmark at a six-year high of 4 percent amid the fastest inflation in almost 16 years.

The gap in rates makes it more profitable to hold euros than dollars. Investors predict the Fed will cut rates again this month, while ECB council members attending the Washington talks indicated no plans to follow soon.

"I don't see any room to cut rates given the current environment," said Bundesbank President Axel Weber. Belgium's Guy Quaden said in a Bloomberg Television interview that inflation is "well above our definition of price stability."

Diverging economic interests mean the G-7 will also be wary of trying to buck the $3.2 trillion-a-day currency market by buying dollars, said Alan Ruskin, head of international currency strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut. "The statement reflects an attentive G-7, but not a G-7 that either carries a bigger stick or is prepared to use it," Ruskin said.

Though traders may be wary of selling the dollar as aggressively as they have been, they may "test" the G-7's appetite to defend it by pushing the currency toward $1.60 per euro, said Goldman's O'Neill, who correctly predicted the G-7 would toughen its language. The dollar closed at $1.5808 per euro on April 11.

* * *

GATA is grateful for financial contributions, which
are federally tax-deductible in the United States.