The euro has made a sharp recovery against the dollar over the past month of about 7.5 per cent, reaching $0.92 before some profit-taking. The euro has also strengthened by 3.5 per cent against sterling over the same period.
This correction in currency markets is more a shift in sentiment away from the dollar than an indication of a more positive attitude towards the euro.
Over the past month, sterling and the yen have also strengthened against the US dollar, the former by 7.5 per cent and the latter by 3.7. The euro's better performance against the dollar than other currencies reflects the low level of the single currency at $0.855 in mid-July. This was only $0.03 above the euro's all-time low against the US currency.
Despite the latest resurgence, the euro/dollar rate remains within a well-established trading range of $0.85-$0.95.
The currency's recovery over the past month reflects a change in tone of assessments on the prospects for an imminent US economic recovery. The cautious tone contained in Mr Alan Greenspan's monetary policy statement to Congress in mid-July and the message of continued economic weakness conveyed in the Fed's Beige Book, published earlier this month reduced market expectations of a short-term recovery in the US economy.
Real GDP data for the second quarter showed a further sharp downturn in investment spending. With additional cutbacks in investment expected in coming quarters, a sustained recovery in the US economy appears to be some way off.
On a more positive note for the US economy, consumer spending is holding up reasonably well. Retail sales figures for July were better than expected. Unless consumer spending stops growing, or falls, the US is likely to avoid recession.
Market opinion is divided on the short-term outlook for the dollar. One view sees the euro rising to $1-$1.10 over the next 12 months as the US economy suffers recession or near recession conditions and as the markets focus on the massive US balance of payments deficit.
The International Monetary Fund (IMF) this week expressed concern about the risks to the dollar from the high US balance of payments deficit. The release of this report pushed the euro above the $0.90 level.
There was nothing new in the IMF's assessment of the US economy. However, in thin holiday conditions, the IMF's warning was another factor contributing to increasing gloom about the US economy.
An alternative view is that the euro will fall back to $0.80-$0.85 once the US economy starts to show signs of recovery and as the euro economy remains weak. The US Federal Reserve has cut rates from 6.5 per cent to 3.75 per cent since the start of the year.
This easing of monetary policy, together with tax cuts, should support the economy in the short term.
Furthermore, the Fed seems set to cut again when the Open Markets Committee meets on August 21st. Further cuts beyond that cannot be ruled out. The European Central Bank (ECB), on the other hand, has been slow to respond to the sharp fall-off in euro-zone economic prospects.
Over the past month, the markets have focused on the weak US economic data. However, they have not ignored the slew of weak German economic statistics. It is likely that the spotlight will shine back on the ECB at the end of August. A failure to cut rates will be negative for the euro.
In summarising recent foreign exchange developments, there has been a shift away from the overly negative focus on the euro towards a more balanced realisation that the dollar's lofty performance in the first half of 2001 was not justified. In the short term, the euro is likely to stay within its $0.85-$0.95 range. The euro/US dollar exchange rate will reflect the ebb and flow of market attention on US and euro-zone economic data.
A break towards parity seems some way off, as indeed does a fall towards $0.80.
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