In a new column Steven Andrew takes a view of the global economy and the UK’s place in it. This week, events across the pond need close attention
In the weeks since the US Presidential election, fears of a disruptive decline in the dollar have intensified. Since 2 November the US dollar has fallen by 3 per cent against the Japanese yen, 2.5 per cent against the euro, and is 1 per cent lower versus sterling.
In a global sense, then, the skew towards the euro as the main outlet for dollar weakening is rebalancing just a little with the Asian currencies maybe starting to take greater strain. On a trade-weighted basis, the dollar has dropped 1.3 per cent in the past two weeks, taking its cumulative decline to 27 per cent from the January 2002 peak. As we’ve said before, medium-term fundamentals (manifested by the huge current account deficit) suggest the dollar bear market is unlikely to end any time soon - though we continue to hold the view that, in the absence of a compelling non-US investment alternative, the prospect of a severe ‘correction’ appears slim.
From a policy perspective, US economic interests would be best served by a steady, gradual dollar depreciation (even better if combined/inspired by stronger demand growth from outside the US). This would allow some rebalancing to take place between the savings-short US personal sector and growth in the rest of the world. Of course, the price of the currency should, in theory, spend more time reflecting fundamental factors rather than driving them. It is not at all clear that a gradual decline in the dollar will by itself provoke a significant fundamental response.
The risk is that a large shift in the currency is required to have a material impact upon US fundamental growth prospects. There is a strong correlation between changes in the US terms of trade (export prices relative to import prices) and personal consumption (70 per cent of GDP) only during periods on sharp relative price movements. During more shallow price shifts, the relationship has been virtually non-existent.
In an ideal world, the dollar will depreciate steadily (and disproportionately, from here, versus the Asian currencies) crucially pushing longer-term US yields up as foreign appetite wanes. The worst outcome, of course, would be a sudden collapse in the dollar, leading to sharply higher Treasury yields as investors flee dollar-based assets. Such behaviour has in the past been consistent with a recession in the US household sector.
History tells us that modest moves in the currency have, by themselves, been largely insignificant as a driver of economic growth. With the dollar increasingly in focus as the remaining source of economic stimulus, the risks are high that what’s seen as a ‘desirable depreciation’ needs to turn into a debilitating collapse to have any significant economic impact.
Key developments this week
Softer UK economic data released reinforces the case that base rates have peaked at 4.75 per cent. The latest MPC minutes were very much aligned with the views presented in the Bank’s November Inflation Report. Futures markets continue to price-in a rate cut in the second half of next year.
UK labour market data disappointed expectations for second consecutive month in October with the official claimant count measure rising by 900 versus and expected drop of 2,000.
UK high street spending at the start of the Christmas shopping season got off to a lacklustre start with official retail sales data coming in well below market expectations at –0.4 per cent mom.
Steven Andrew is an economist at F&C Asset Management plc
