Accepted wisdom in the marketplace currently sees global interest rates rising modestly sometime during the second half of the year.

This has been particularly true in the US, where short-term interest rates are at 40-year lows. The Federal Funds rate, which sets the official benchmark for US interest rates, remains at 1.75 per cent.

Despite the apparently strong economic growth experienced by the US for the first half of the year, the Federal Reserve has been very slow to begin the process of raising interest rates.

The reasons for the Fed's reluctance on this front would seem to be twofold. Firstly, there is a fear that the current economic recovery could run out of steam leading to a "double-dip" recession; secondly, and probably more importantly, inflation remains subdued and there are no signs of emerging inflationary pressures in the US economy.

Despite the current consensus view that some rise in US interest rates is inevitable, there are some that are more sceptical.

Former Federal Reserve governor Mr Laurence Meyer, who now runs a forecasting consultancy, has said recently that the Fed could cut US interest rates if economic growth remained below approximately 3 per cent for a prolonged period.

Mr Meyer, who is a highly regarded economic forecaster, argues that the current US economic data are too mixed to justify an imminent interest rate rise. Indeed, the behaviour of the dollar exchange provides another indication that the US economy may be softening. Since the turn of the year the dollar has depreciated by 9 per cent against the euro.

However, the story in the foreign exchange markets in 2002 is just as much about a resurgence in the euro as about dollar weakness. As the table shows, the euro has appreciated against all major currencies so far this year and it could well appreciate above parity against the dollar in the second half of the year.

The US economy continues to run a very large deficit on the current account of its balance of payments. This deficit has persisted at a very high level for several years. While the US stock market was strong, capital flows into the US economy were sufficiently large to comfortably fund these deficits. However, the US stock market is now into its third year of negative returns and international capital flows now seem to be moving in favour of the euro.

This recent bout of strength in the euro could well have implications for interest rate policy in the euro zone. The view of most commentators is that the European Central Bank (ECB) will engineer a modest rise in interest rates later in the year. Several board members of the ECB have pointed to inflationary pressures in the euro zone as a continuing cause for concern. Euro-zone inflation is already running above the ECB's target of 2 per cent and they are worried that stronger growth later in the year could have inflationary consequences if interest rates are not increased.

However, if the euro continues to appreciate, the ECB may stay its hand since the stronger euro will act to put downward pressure on prices. A currency appreciation of 10 per cent may be expected to depress price inflation by about 0.5 per cent, albeit after a lengthy time lag. Further strength in the euro looks likely and this will undoubtedly be watched carefully by the ECB.

In effect a substantial appreciation of the euro has the same downward impact on inflation as would a tightening in monetary policy.

One might also expect that the impact on US monetary policy of a weakening currency would be symmetrical. In other words, because the weak dollar puts upward pressure on US inflation the US authorities should respond by raising interest rates to nip inflation in the bud. While in theory this may well be the case, it is unlikely to have this impact, given current US economic circumstances.

This is because the dollar would seem to be weak because of declining expectations about the US economy over the medium-term. This is reflected in the weakness of US equity markets. Therefore, the US economy may need a lower dollar exchange rate to improve overall competitiveness and the US authorities may well be prepared to accept somewhat higher inflation in such a scenario.

As such, it could well be that the appreciation in the euro and the mirror-image depreciation of the dollar serve to keep both euro and dollar interest rates at low levels through most of the second half of 2002.