The US dollar continued to defy the slowdown in the US economy yesterday, powering higher across the board in the foreign exchange markets.
The euro dropped to its lowest point in more than three months, trading back below $0.89. "The euro is falling near to some fairly key levels," said Mr Marc Chandler, chief currency strategist at Mellon Bank in New York. "If it goes below $0.88 then the market may start to look at new record lows."
The dollar also reached its highest level in more than three months against sterling and soared to a fresh 22-month high against the Japanese yen, which continued to suffer from the monetary easing announced by the Bank of Japan on Monday.
Expectations of monetary easing worldwide were scaled up yesterday. Interest rate futures for the US, UK and euro-zone all rallied, pointing to more aggressive rate cuts by central banks.
But the focus was on the European Central Bank (ECB). Its chief economist, Mr Otmar Issing, yesterday signalled that the ECB was leaning towards an interest rate cut, playing down price risks and saying the economic outlook had dimmed.
Mr Issing said forecasts for the area would have to be revised down as the world economic environment had worsened "significantly" since late 2000.
These comments, combined with this week's unexpectedly large slide in the Ifo index of German business confidence, has provoked a sharp rally in the euribor strip. Money markets are pricing in cuts of between 50 and 75 basis points between now and September.
Foreign exchange strategists are baffled at the dollar's latest rise. "Either the dollar is losing touch with reality or I am," said Mr David Bloom, currency strategist at HSBC. US stock markets have been leading world prices lower; the flow of merger and acquisition capital into the US looks to be slowing; and the premium paid by US bonds over their European counterparts has all but disappeared. Despite this, the dollar has continued to rise.
The favoured explanation for the dollar's strength against the euro has been that an intransigent ECB would hold back growth by keeping rates too high. But this explanation is looking weak as the ECB edges towards rate cuts.
The "safe-haven" theory, which suggests investors are fleeing tumbling equity markets for the safety of the dollar, is also waning.
"The US is the epicentre of the downturn and therefore an unlikely destination for safe-haven flows," said Mr Peter von Maydell, senior currency strategist at Credit Suisse First Boston. Last year, forecasters expected the euro to have risen to $1.087 by now, according to Consensus Economics, the financial pollster. That's a long way from yesterday's close of $0.884. Without any clear explanation, analysts argue that dollar strength is an anomaly that should soon be corrected.
