Deficit fears overshadow sales data as dollar falls

The dollar failed to build on positive US retail sales data yesterday, dropping back against major currencies as investors worried about the size of the US current account deficit.

The euro, which fell to $1.1221 in early European trade, was at $1.132 by the middle of the day in New York.

Sterling and the Swiss franc tracked the euro's gains, with the pound rising to $1.609 from $1.5965 and the franc pushing the dollar back to 1.3638 Swiss francs from 1.3758 Swiss francs.

"Markets do not feel comfortable projecting July's strong data pattern on the rest of the year," said Ms Lara Rhame at Brown Brothers Harriman in New York, who suggested that yesterday's numbers confirming strong consumer activity had simply increased market concerns about the size of the US current account deficit.

The deficit, in part the result of consumer buying of imports, leaves the dollar dependent on strong foreign capital inflows and vulnerable to depreciation if those flows tail off.

"We don't think US growth being stronger than the rest of the world will be enough to foster dollar gains any more," added Ms Rhame.

Retail sales beat analysts' expectations with a 1.4 per cent increase in July. Consumer spending is a closely-watched barometer of overall economic health because it accounts for roughly two-thirds of US economic activity.

Even as corporate scandals raged and the stock market stumbled, consumers kept the economy moving with retail spending and home refinancing.

US retailers have been stung this year by uncertainty over the war in Iraq, unemployment and lacklustre consumer confidence, giving consumers little reason to spend.

IIB Bank's chief economist, Mr Austin Hughes, was cautious on the July rise, however. He questioned whether the strength would endure as the impact of a recent tax cut fades and borrowing costs rise.

There is a fear in the market that rising bond yields could inhibit economic recovery by leading to more expensive borrowing.

Mr Hughes believes the Tuesday decision of the Federal Reserve to leave interest rates at historically low levels was the monetary authority's way of telling the market that it had made a mistake on term interest rates.