Goldman expects 'modest' fall in dollar, interest rate cuts

By Jessica Mortimer
AFX News via Forbes.com
Monday, January 15, 2007

http://www.forbes.com/markets/feeds/afx/2007/01/15/afx3328780.html

LONDON -- The dollar is set for modest declines in 2007 as US growth continues to slow, prompting the Federal Reserve to start cutting interest rates, according to Goldman Sachs.

"We see a modest decline in the dollar over 2007, which will be good for world markets rather than bad," Goldman's head of global economic research Jim O-Neill told a conference on global strategy here.

Goldman forecasts that the euro will rise to 1.32 against the dollar by the end of the year from just below 1.30 currently.

There are signs that some of the capital flows that had previously supported the dollar are starting to deteriorate, with the number of buyers of US bonds and equities from the rest of the world falling, he said.

Another potential negative factor for the currency is Goldman's forecast that slower growth and subdued inflation will prompt the Fed to start cutting interest rates this year.

The investment bank forecasts that US rate-setters will cut borrowing costs three times during the year, starting in the second quarter, taking the Fed Funds rate down to 4.50 percent from 5.25 currently, O'Neill said.

On the positive side, however, the US trade deficit is showing signs of significant improvement as export growth has begun to overtake growth in imports, helped by the weaker dollar. This should enable the current account deficit to start improving this year.

Meanwhile, other major economies are set to weather the US slowdown fairly comfortably as they become increasingly less dependent on the US.

"If ever there was a good time for the US to slow, this is it," he said.

China is showing "no sign of slowing," while more importantly there is growing evidence that Chinese corporate profitability is improving.

In Japan, companies are increasing their workforces and business confidence is spreading to non-manufacturing, a sign that domestic demand is recovering. Germany too is "way through the problems created by reunification."

"The improvement in Germany's competitive position has led to a significant improvement in business confidence, which will lead to stronger growth," O'Neill said.

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