An article in Bloomberg notes that despite the dollar bounce against the euro (the move against the yen can be characterized as noise), the Group of Seven will probably need to take “concrete steps” to support the currency. And those aren’t coming any time soon.
As the piece notes, the ECB is still concerned about inflation and thus not eager to lower rates. Our Japanese sources with top-level government connections tell us the island nation didn’t see the rise in the yen above 96 to the dollar as reason to consider intervention, which suggests they may sit on their hands until the dollar is below 90 yen, perhaps even approaching 80 yen.
But there is another element that the article does not follow up on: currency volatility. While rates are seldom stable, rapid movements in FX prices undermine international trade. They make pricing, procurement, and investment difficult and unreliable. While the G7 may eventually make a credible move to put a floor under the dollar, there isn’t as obvious a remedy for well founded skittishness.
Note that we doubt that intervention could do more than slow the dollar’s slide. While currencies often appear immune to fundamental forces for quite a long time, the US current account deficit is so large as a percent of GDP as to exert continued pressure on the currency. The US needs to get its savings rate up if it wants to salvage the greenback.
Note that while Bloomberg implied that this communique might be a prelude to intervention similar to that to bolster the euro in 2000, the Financial Times argues that the G7 ministers are deeply worried:
The Group of Seven industrialised nations has signalled shared concern over the danger of a disorderly slide in the dollar and sterling, following bouts of extreme weakness in the two currencies in recent months.
The warning came in a new sentence of the G7 communiqué, which said “there have been at times sharp movements in major currencies, and we are concerned about their possible implications for economic and financial stability”.
The G7 pledged as before to “monitor exchange markets closely and co-operate as appropriate”.
Group of Seven officials, signaling concern over a sliding dollar for the first time in 13 years, may have to match talk with action before the currency stages a sustained rebound.
U.S. Treasury Secretary Henry Paulson, European Central Bank President Jean-Claude Trichet and G-7 counterparts warned after talks in Washington on April 11 that recent “sharp fluctuations” in exchange rates risk hurting the global economy.
Sounding the alarm over the weakest dollar since the 1970s may still fail to buoy it so long as the ECB refuses to follow the Federal Reserve in cutting interest rates. Wariness of backing rhetoric with intervention may also limit the new language’s effectiveness.
“Officials are clearly more concerned about the dollar, but are not yet ready to openly threaten the market because they know they would not be credible with the ECB’s reluctance to lower interest rates,” said Stephen Jen, head of currency research at Morgan Stanley in London.
The dollar rose to $1.5722 per euro at 12:08 p.m. in Tokyo, from $1.5808 late in New York on April 11. It earlier reached $1.56 a euro, the strongest level since April 3. The currency strengthened to 101.15 yen from 100.95….
The change represented a victory for European governments increasingly concerned that the dollar’s slide threatens their exports. “I hope this concerted wording on currencies will help,” French Finance Minister Christine Lagarde said in an interview with Bloomberg Television…..
While the G-7’s currency warning may help temper the dollar’s descent, central banks would have to realign their monetary policies to reverse its direction, analysts said….
Diverging economic interests mean the G-7 will also be wary of trying to buck the $3.2 trillion-a-day currency market by buying dollars, said Alan Ruskin, head of international currency strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut. “The statement reflects an attentive G-7, but not a G-7 that either carries a bigger stick or is prepared to use it,” Ruskin said.
Though traders may be wary of selling the dollar as aggressively as they have been, they may “test” the G-7’s appetite to defend it by pushing the currency toward $1.60 per euro, said Goldman’s O’Neill, who correctly predicted the G-7 would toughen its language. The dollar closed at $1.5808 per euro on April 11.