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It may cool US inflation, but hit exports

If exports become costlier, they could weigh on an already huge trade deficit

(WASHINGTON) The dollar’s recent gains are cutting both ways for the US economy, cooling inflationary pressures but also threatening to choke exports, the life support for the ailing economy.

The greenback, which fell to a record 1.60 against the euro in mid-July, has since enjoyed a month-long rebound.

The upward trend, however, has zigzags. Late on Tuesday, the dollar slipped back on a pair of worrying US economic indicators, pushing the euro up to 1.4783 dollars in New York.

‘The appreciation will continue, it’s not going to be all straight line after such a huge advance that we’ve seen in the last couple of weeks. You get some consolidation and it gives back a little bit before resuming the stronger path,’ said Stephen Gallagher at Societe Generale. ‘In the next six months we can look to move to 1.40 (dollars) versus the euro.’

The reason for the dollar’s ascendance, economists point out, is the growing pessimism about the health of the eurozone and Japanese economies, rather than renewed confidence in the US economy.

‘A few months ago, people were talking a lot about decoupling and that the global economy would do fine even if the US economy was stepping into recession,’ Mr Gallagher said.

The market has undergone a major re-evaluation of that theory in recent weeks, he said, and come to ‘the recognition that the US consumer is in a weak state and that the rest of the world economy would also suffer because of that’.

Nonetheless, the rise in the dollar is positive for the US economy on the inflation front, analysts note, as it is often accompanied by a drop in energy prices.

‘Oil by itself coming down is a good thing, the US dollar going up by itself is a good thing both from (an) inflation standpoint, because they are disinflationary,’ said Drew Matus, senior US economist at Merrill Lynch.

A stronger dollar makes imports cheaper, thus limiting the risks of ‘importing’ inflation into the economy.

Federal Reserve chairman Ben Bernanke in June voiced concern about the risks of a weak dollar undermining price stability as the sluggish economy battles housing and credit headwinds.

The dollar’s new buying power should bring inflation relief after consumer prices leaped 5.6 per cent in July to a 17-year high. But if it costs less to import, exports become more expensive, and that threatens to weigh on the already massive US trade deficit.

And if the recovery of the dollar stems from deteriorating global economic growth, Americans will see exports dwindle.

That poses a risk for US growth, since foreign trade presently is one of the few engines firing in the economy.

‘Obviously if the appreciation continues to occur, it might dampen some of the export growth we’ve been experiencing,’ Merrill Lynch’s Mr Matus said.

Mr Matus recalled that in the trade sector, ‘it takes a long time for the exchange rates to play out’, from six to 12 months. ‘That’s why it took a long time for the US economy to get a boost from the weakening dollar.’

US companies likely will be the first to feel the effects of the stronger dollar. While most of the major firms have posted strong financial results recently, ‘it’s because they have greatly benefited from the strength of exports’, said Gregori Volokhin at Meeschaert Capital Markets.

Soft drinks king Coca-Cola, for example, has seen its second-quarter operating profit jump 16 per cent in Europe, while Kellogg Company, the cereals and snacks maker, posted a 17 per cent rise in international revenue.

‘A strong rebound of the dollar is not necessarily what is best for certain sectors of the economy,’ Mr Volokhin warned. — AFP

Source : Business Times - 21 Aug 2008