Economists are divided as to how high, if at all, the US Federal Reserve will hike interest rates. But the signs are there for a slowdown in US growth, ending the dollar's surge against European currencies.
"Interest rates in Europe are close to neutral but not restrictively," says Paul Mortimer-Lee, head of market economics at BNP Paribas. "Therefore, European growth will be 3.5% this year and close to 3% next year, and for the first time in many years you will see Europe growing faster than US next year. We think that that will have a big impact on the currency market."
Some volatility has also been predicted within the Asian region as a result of the weakened dollar. BNP economists, speaking at a conference yesterday, predict that the yen will not move significantly higher against the dollar in the near term. The six-month yen/dollar forecast is Ñ102 to $1 while the 12-month projection is Ñ108 to $1. BNP economists cite doubts over the economic recovery, political concern, and a weakening stock market as the reasons for the less-than-significant move by the yen against the dollar.
However, in the long term, BNP economists expect the Bank of Japan to shift away from its zero interest rate policy in the third quarter, and this, coupled with further improvement in growth fundamentals should allow the yen to resume its strength in the long term. The improvement in growth fundamentals is led by improved cash flows within the Japanese private sector. "Corporate cash flows have improved, this will spill over into summer bonus for employees, and this in turn will increase consumer spending," says Mortimer-Lee.
Asian currencies will hold up well
According to American Express Bank senior economist Kevin Grice, expectations of an US rate hike will return in July or August, boosting the dollar and therefore weakening Asian currencies over the next three months. But Grice adds that, broadly speaking, Asian currencies will hold up quite well.
"When the US slows, youÆll get stability at worst, and perhaps appreciation for a number of currencies in the region," says Grice. "Ones that will do particularly well are the Taiwan dollar, the Singapore dollar, and the Malaysian ringgit." The bank believes that the 'hi-tech' image projected by those countries, and lower policy and political risks are crucial to the currencies' performance.
Grice also believes that the Malaysian ringgit will appreciate slightly if its peg is removed, as it is currently significantly undervalued. However, he does not believe the peg will be removed in the near future. Grice predicts the rupee, the Philippine peso, the baht and the won will all experience stability.
Rmb devaluation on the way?
With regards to the renminbi, Grice anticipates a gradual widening band over the next six months.áHe says devaluation is likely over the course of 2001, in reaction to the adjustment process during the early years of World Trade Organization membership.
BNP economists expect the US to increase interest rates by 50 basis points, while the American Express Bank forecasts the Federal Reserve to tighten rates by another 50bp to 75bp.