Euro continues to rally after Greenspan lulls US rate fears

The euro has rallied for the second day, following comments from the Federal Reserve chairman, Mr Alan Greenspan, which suggested there may be no more rises in US interest rates.

In his twice-yearly Humphrey Hawkins testimony to Congress, Mr Greenspan said the economy was showing signs of cooling and impressive productivity growth had helped remedy imbalances, which could reduce inflation risks. At the same time, euro zone interest rates are generally thought to be on the way up, with some analysts predicting they may rise by a full percentage point by the end of the year.

According to Mr Jim Power, chief economist at Bank of Ireland, the euro's resurgence may only be temporary as it is being boosted by profit taking and exaggerated by trading in very light markets.

But according to Mr Steve Barrow, a currency strategist at Sterns International, the euro is set to rise to around $0.96.

"We suspect rates have peaked in the US. In two to three months, the European Central Bank will raise rates, which will help redress the balance with the US, and lift the euro to as much as 96 cents," he said. The euro rose to $0.9350 from $0.9297 late on Thursday and was partly underpinned by news that French industrial production rose 0.7 per cent in May, up from a 0.2 per cent drop in April.

France, the euro area's second-largest economy, is leading the region's recovery, with growth this year expected to speed to 3.6 per cent.

The combination of faster growth, a weaker euro and higher oil prices and, hence, inflation in the euro region is fuelling expectations the European Central Bank will boost rates in the coming months, analysts said. US interest rates are currently at 6.5 per cent and euro zone rates at 4.25 per cent, a 1 percentage point rise would narrow that gap substantially.

The euro has lost 8.7 per cent against the dollar in the past six months, boosting the cost of imports, while the price of oil has risen by 50 per cent in the past year. "If ex-energy inflation continues to rise next month, then rates could be increased earlier than the ECB's September 14th meeting," said Mr Chris Iggo, head of European economics at Barclays Capital Group.

However, many investors still remain optimistic on the dollar, even in the face of recent declines, analysts said. In his report to Congress, Mr Greenspan said: "So long as foreigners continue to seek to hold ever-increasing quantities of dollar investments in their portfolios, as they obviously have been, the exchange rate for the dollar will remain firm." Analysts also point out that recent steady gains in stocks and bonds will also help boost the dollar. As one trader noted: "Even though the US economy has slowed down, the economy is still strong, compared with other industrialised nations."