After a great run, the dollar may run out of steam

After a great run, the dollar may run out of steam

Alan McQuaid

The US central bank left interest rates unchanged at its latest monetary policy meeting in the past week.

However, solid economic growth combined with rising inflation is likely to keep the Fed on track for another two hikes this year even as President Donald Trump has ramped up criticism of its push to raise rates.

Additional quarter-point increases in September and December would bring the US central bank’s key interest rate into a target range of 2.25% to 2.50%, and mark the ninth increase in the tightening cycle which began in December 2015.

In contrast, the ECB has yet to raise rates since the end of the global financial crisis.

At its June 14 policy meeting, it pledged to hold down interest rates until past next summer and indeed it is quite possible that ECB President Mario Draghi will not have overseen a rate-hike by the time his eight-year term in office comes to an end at the end of October next year.

It has been a good year overall for the dollar, so far.

The current rally is three months old and, despite some clouds over the US growth outlook, the gains may have a bit further to go.

Since mid-April, the dollar has risen nearly 6% against a basket of currencies, hurting emerging markets and inflicting losses on speculators who had bet that the currency would extend its 10% in 2017.

Their bets paid off in the first quarter when the dollar tanked nearly 4%.

But since then, signs of faltering growth elsewhere in the globe and then the trade war have pushed capital towards the US.

Many currency analysts remain convinced the dollar has had its day, noting US economic growth is likely to have peaked.

But most of those polled by Reuters in its most recent currency poll see the dollar’s allure lasting another six months.

In early 2018, encouraging European data fostered a view of a synchronised economic recovery that could lead to global interest-rate rises.

But that view has dissipated.

Indeed, the Bank of England played down rate-rise expectations in April and the eventual hike last Thursday is unlikely to be followed up with more moves anytime soon.

That doesn’t bode well for sterling, especially with the whole uncertainty of Brexit hanging over its head.

Protectionism may also be playing a role in boosting the dollar.

The US, whose exports are worth 12% of its GDP, looks less vulnerable to a trade war than, say, Germany, which has an export-GDP ratio of around 45%.

Support for the dollar has also come from the emerging market capital exodus.

That said, a strong dollar does not fit in with President Trump’s plans to boost US exports and cut US trade deficits with its trading partners. We wouldn’t be surprised to see a stronger euro versus the dollar on a six-to-12 month view.

Alan McQuaid is chief economist at Merrion Capital.

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