US company accounting scandals, not a weak economy, have weakened the dollar against the euro, writes Oliver Mangan.

After two unsuccessful tries at parity in recent weeks, the euro climbed above the one-to-one hurdle against the dollar yesterday. This came as no surprise to financial markets, which had been anticipating such a move.

The breach of parity had been delayed as Japan had intervened recently to sell its strengthening currency. The Japanese authorities were concerned that the dollar's slide could derail the export-led rebound in economic activity in Japan.

This gives a clue about what is going on in financial markets. It is not a euro-recovery story. Rather, the US dollar has been losing ground on all fronts in recent months. The euro has been quite stable this year against most of the other major currencies, in particular the yen and Swiss franc. But it has registered some modest gains against sterling.

The dollar's decline is not being driven by a weak US economy. Indeed, there has been a marked rebound in US economic activity during the first half of this year. The recovery in economic activity is expected to be sustained during the second half of the year and into 2003.

The US, though, runs a very large balance-of-payments deficit amounting to around $450 billion (€453.3 billion) annually. Until this year, this was financed by large capital inflows into US equities and bonds. The series of accounting scandals that have hit Wall Street this year has seen a marked fall-off in these capital inflows, as investors have lost faith in US financial assets.

Indeed, the dollar's decline mirrors that of US stock markets over the past four months. In addition, there has been a subtle but perceptible change in US exchange rate policy. Gone is the unequivocal strong dollar policy of the Clinton administration. Benign neglect is the unstated policy of the Bush administration. It is not unhappy to see the dollar decline as this relieves some of the pressure on corporate America.

Dollar weakness is likely to remain a key feature of financial markets over the balance of the year. Thus, the euro can be expected to gain further ground against the dollar. A move up to the $1.01-$1.02 level is likely this week, and we would expect the euro to rise to $1.04-$1.05 against the dollar in the coming months.

This, however, is still well below the launch value of around $1.17 for the euro in 1999. If the dollar is to halt its downward spiral, confidence must be restored in US financial assets and, more broadly, in US corporate governance and accounting practices.

The rise of the euro against the dollar makes life difficult for exporters from the euro zone. But it should benefit the economy as a whole. One benefit of the euro's rise is that the ECB has deferred interest rate increases that seemed very likely only a few months ago.

It will also put some downward pressure on inflation. Both developments improve the prospects for a pick-up in consumer spending and give a better balance to the recovery in activity currently under way in the euro zone.

Oliver Mangan is chief bond economist with AIB Group Treasury