Foreign Currency Report 18 July 2008

Sterling and Euro take a back seat as the Dollar once again drives the markets:

The Pound exchange rate retreated against the Euro yesterday as UK inflation data and jobless figures released earlier this week added to gloom surrounding the UK economy. The number of Britons out of work jumped by the largest amount since 1992 in a deepening UK economic downturn.

Average earnings growth eased in May, in a sign that higher living costs have yet to feed through into wages even though inflation hit a series high of 3.8 percent. The outlook for Sterling is still negative for the Pound, and with rising unemployment for five months in a row, it's unlikely that there will be too much pressure for wage growth. High inflation, driven by record high oil prices, has been a factor in keeping the pound afloat, but newly appointed Bank of England chief economist Spencer Dale said on Wednesday there was a risk that slowing output could eventually lead to inflation falling below its 2.0 percent target.

The Euro on the other hand remained well following hawkish comments from European Central Bank governing council member Nout Wellink. Wellink stated that a slower economy will not reduce inflation, and said that experiences in the 1970s showed if you did not act early to contain inflation it could persist for the long term.

"It's a mistake to think that inflation will fall if the economy weakens. We have seen that too in the 70s," he said. In addition a report in the Financial Times that some of the world's largest sovereign wealth funds are diversifying out of their Dollar-denominated assets has also given support to the single currency against the greenback.

The FT said one major fund in the Gulf has cut its Dollar-denominated holdings from more than 80 percent to less than 60 percent over the past year.

US Dollar

As the title of my market report states, the main focus of money markets is once again turning to the U.S. to see whether there will be yet another bout of volatility to provide the Dollar and indeed its major counterparts with further direction.

A major rally on equity markets on Wednesday, driven by strong corporate earnings reports, a falling oil price and punchy U.S. inflation figures helped the dollar bite into some of the losses we have seen in the last week. These however have proved short-lived as investors remain uncertain about the future of government sponsored mortgage giants Freddie Mac and Fannie Mae.

If we do continue to see the US Dollar exchange rate weaken then it may result in the US Government intervening in Markets to Prevent Run on the Dollar. In a recent testimony Ben Bernanke, stated that "Dollar Intervention should be done rarely" but that it "may be justified in disorderly times." Due to the real risk of a run on the Dollar, the U.S. government and many others are openly talking about intervention in currency markets to support the Dollar by buying the currency and it is likely that this intervention might also take the form of selling gold, the anti Dollar, in order to support it.

A similar situation occurred back in 2000, when it was urged for the world's big central banks to calm the markets; back then it was the Euro's seemingly endless slide which was perceived to be destabilising the world economy. Now, it is the plight of the U.S. Dollar that is ringing alarm bells. The greenback exchange rate set record lows again on Tuesday in its alarming downward spiral as severe questions are being asked by overseas investors about the financial reliability of the world's biggest economy and its financial obligations. Once lost, investor confidence can take years to restore.

The risk to the Dollar in that environment is stark and given few governments around the world have any interest in seeing a further devaluation of the U.S. currency, support for concerted intervention is on the rise. The Dollar's decline has clearly exaggerated oil and food prices worldwide, complicating monetary policies from the United States to the Euro zone and Britain as well as to the export-oriented economies of Asia and the Middle East. As the world economy slows after a year of credit turmoil, Dollar-exaggerated inflation has tied the hands of central banks everywhere from cutting interest rates, and Dollar losses also squeeze the export-driven growth engines of emerging economies.

My personal opinion is that if we do see some sort of government intervention then it will strengthen the Dollar exchange rate and as well as making the US currency more expensive to buy it will have a ripple effect for all the major currencies. Here at FC Exchange we work tirelessly to give clients as much information on what factors will effect your chosen currency purchase. We are the experts in the field and during these volatile times, lets face it we all need as much help as we can get, so feel free to contact me or any of my colleagues and we will be happy to help. Simply call +44 (0) 20 7989 0000 or email jrs@fcexchange.co.uk