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Wednesday, 16 May, 2001, 21:07 GMT 22:07 UK
Strong dollar policy
One US dollar
Economic problems have not weakened the dollar
By BBC News Online's North America Business Reporter, David Schepp

While the US economy has shown signs of weakness in recent months, such is not the case for the American dollar.

Despite a precipitous drop in technology stocks that has seen the Nasdaq technology-based index tumble by nearly 60% from its record high, the dollar remains buoyant.

"We would have assumed that the US dollar would have been hit harder by the slowdown in the economy and relative growth rates," says Sean Callow, currency strategist at private forecasting firm IDEA Global.

But foreign investment in US markets remains strong, and the US central bank's aggressive actions in recent months to keep the faltering economy from slipping into recession have firmed up confidence in world's largest economy.

"We're operating in an environment of global economic uncertainty, and market participants want to see central banks cutting interest rates to boost growth," says Alex Buezelin, foreign exchange market analyst at Ruesch International.

Masterful moves

"I think there has been some insulation for the dollar from the Fed's aggressiveness and willingness to show it's committed to growth on a long-term basis," said IDEA Global's Callow.

A series of masterful moves by the US Federal Reserve has instilled confidence among currency traders. The Fed's most recent effort came on Tuesday when it cut its benchmark interest by a half percent for the fifth straight time this year.

Analysts believe the latest drop in interest rates bodes well for continued strength in the dollar. And tame economic data showing strength in parts of the US economy have allowed the central bank to take such bold moves.

On Wednesday, the Labor Department revealed that consumer prices rose slightly less than expected in April, advancing 0.3%.

This confirmed the subdued inflation climate that the Fed says has allowed it to make its aggressive interest-rate cuts.

The modest advance in the consumer price index (CPI), the key measurement of inflation, followed a 0.1% increase in March, the US Labor Department reported.

Stumbling euro

The euro by contrast has stumbled in recent months, having fallen nearly 10% against the US currency since January.

From a value of $1.04 per euro in early 2000, the euro fell to a low of 83 cents last October, according to the International Monetary Fund (IMF).

Even after a subsequent rebound the euro continues to trade in the range of 88 cents to 95 cents, well below estimates of its true value.

Driving the weakness in the euro are concerns about the currency's governing body, the European Central Bank (ECB), whose previous hard stance on maintaining interest rates caused some to question ECB policies.

Last week the ECB's credibility was further eroded when it chose to cut interest rates after months of saying it would not make such a move.

"What the ECB did was a small step in the right direction," says Sonja Hellemann, foreign exchange strategist for Dresdner Kleinwort Wasserstein in London.

"But in the current environment of global economic uncertainty many say the ECB's action may prove insufficient, spelling bad news for the euro."

Analysts say the ECB was hoping for a positive response similar to the one that enveloped US markets when the US central bank made a surprise inter-meeting rate cut on 18 April.

"It's almost like a double evil for the euro," said Bernard Tsui of Union Bank of California. "When the Fed cuts, it is good for the dollar. But when the ECB cuts, it is bad for the euro."

Analysts also say that neither the dollar's strength nor the euro's weakness is expected to abate any time soon. But neither do they expect the euro to fall to last October's lows.

Said Union Bank's Tsui "It's not going to be a one-way street for the dollar down to 82 cents."

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See also:

15 May 01 | Business
Fed cuts rates again
11 May 01 | Business
Euro weaker after rate cut
25 Apr 01 | Business
EU downgrades growth estimate
27 Apr 01 | Business
US economy stronger than expected
27 Apr 01 | Business
Q&A: What caused the US slowdown?
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