Dollar Caught in the Economic Crossfire

By Reuters

The Federal Reserve is poised to cut interest rates again this week while the European Central Bank remains on hold for a while, leaving the beleaguered U.S. dollar caught in the cross-fire.

The slumping U.S. currency has contributed to oil's climb to $111 per barrel. It is part of the reason behind investors' mad dash to buy other commodities, ranging from wheat to gold.

The slide is also feeding malaise among European exporters struggling to compete with cheaper

Exchanging Dollars and Euros

U.S. goods, and prompting some big oil exporters who pegged their own currency to the dollar to rethink that policy.

While calls have intensified for official government intervention to stem the dollar's decline, Washington has shown no inclination to act. Finance leaders in Europe and Japan ratcheted up the rhetoric last week as the dollar hit an all-time low against the euro, and sank below 100 yen for the first time in more than a decade. So far, it remains all talk.

Only the Bank of Israel stepped in last week with official action, twice buying foreign currency to cool the shekel, which had hit an 11-year peak against the dollar.

Goldman Sachs strategists called the Bank of Israel's moves "a sign that the pace of dollar decline is becoming more uncomfortable in places."

That discomfort is apparent in recent comments from world leaders. British Prime Minister Gordon Brown said volatility in currency rates "obviously worries people." European Union leaders repeated their view that excessive currency moves are "undesirable," although Eurogroup Chairman Jean-Claude Juncker said Friday they did not discuss any intervention.

In Japan, Chief Cabinet Secretary Nobutaka Machimura said the yen's moves seemed to reflect dollar weakness rather than yen strength. "As for currency intervention, I will not comment," he said at a news conference Friday.

President Bush acknowledged last week that the weakening dollar was contributing to oil's steep upward march. But Treasury Secretary Henry Paulson, the main spokesman for the U.S. currency, stuck to his well-worn script, saying a strong dollar was in the nation's best interest, and healthy long-term U.S. fundamentals would be reflected in exchange rates.


Investors have plenty of reason to dislike the dollar.

First and foremost, there is the matter of interest rates. Official U.S. rates are lower than those in the euro zone and are set to fall further this week.

Then there is the widespread worry that the U.S. economy may have already tipped into a recession.

Ultimately, the weak greenback may force the U.S. central bank to truncate its rate-cutting campaign, should inflation spiral out of control.

However, for at least the foreseeable future, the Fed is full steam ahead. Another set of credit shocks and another round of gloomy economic pronouncements have left little doubt in investors' minds that the U.S. central bank will shave three-quarters of a percentage point off its benchmark interest rate when its policy-setting committee meets Tuesday.

An unexpected drop in February U.S. retail sales, hard on the heels of a report showing a sharp contraction in the job market, cemented Wall Street's view that the world's biggest economy was tipping into recession and could drag everyone else down with it.

A three-quarter-point cut would take the federal funds rate to 2.25 percent, the lowest since December 2004 and less than half of what it was before failing U.S. subprime mortgages froze credit markets last summer.

Across the Atlantic, the ECB and Swiss National Bank both cut their growth forecasts this month, but jacked up inflation expectations. That led investors to conclude that the ECB is unlikely to budge until inflation cools, even as European companies howl over faltering exports. Unlike the Fed, which is tasked with the often-contradictory missions of taming inflation and promoting full employment, the ECB has one main focus -- price stability.

A report Friday suggested euro zone exporters have good reason to be concerned. The ECB report showed euro zone exports were less competitive during the last 12 months, and the pace of erosion was faster than in the previous year.

The International Monetary Fund gave a grim assessment of the world economy on March 12, warning that the credit crisis that began with failing U.S. subprime mortgages was worsening and global growth was at risk. But the Fund also said both the Fed and ECB were acting appropriately.

"The signs of economic distress are much clearer in the U.S. than in the European economy," John Lipsky, IMF first deputy managing director, told Reuters in a recent interview. "There's no subprime mortgage (market) to be melting down."

That also means no relief in sight for the dollar.