Currency markets are in turmoil following the stock market upheaval and the implications are far from clear cut. Yesterday, activity in the market was centred around the relative safe haven status of the deutschmark and the dollar. Early in the session, the dollar lost ground as investors decided it had far too much exposure to the stormy waters in the Far East. As the Dow recovered in the European markets in the afternoon, the dollar picked up a little.
The pound remained broadly stable against sterling and the deutschmark as it diligently followed sterling's every move. However, it gained almost four cents against the dollar. The pound closed at $1.50 from $1.46 on Friday, at DM2.5977 in late trading from DM2.6018 and at 89.42p from 89.51p against sterling.
However, a paper from the six leading German economic institutes, which said the pound will need to be revalued next May for fear over overheating, may have helped support it. According to Mr Jim Power, chief economist at Bank of Ireland, the deutschmark is winning the battle for safe haven status on the basis that the German economy is a lot less exposed in the Far East than the dollar.
He added that the yen looks like a one-way bet based on fundamentals but that political issues around the bilateral trade disagreement between Japan and the US could hamper the Japanese currency's fall.
A Merrill Lynch analyst, Mr Claudio Demolli, pointed out that the crash in shares and currencies in south-east Asia and a slump in shares in G7 countries could have a far more serious impact on the US economy than in Europe.
This, he said, was the main reason why the dollar had fallen so sharply against the deutschmark. "US households on average hold more shares than their European counterparts. A stock market crash will be seen as a reduction in spending power, which could slow the economy. So the US Federal Reserve looks unlikely to raise its interest rates this year," Mr Demolli said.
Up to now the market had been expecting a rise in US interest rates before the end of this year. The address today by the Fed chairman, Mr Alan Greenspan, will be watched very carefully by all markets. Mr Power added that sterling was confused, with no sense of direction. On the one hand, it is seen as a safer haven than the dollar, with the prospect of higher interest rates. Sterling also continued to be buoyed by the parliamentary statement made by the Chancellor of the Exchequer, Mr Gordon Brown. Bond markets also had a good day, from the US to Europe, as investors focused on the deflationary impact of the crisis. Such an environment is traditionally good for bonds, Mr Power noted.
