Friday, March 14, 2008

Euro to Dollar Exchange Rate Forecast

2008 has bought no respite for the falling dollar. The weakening US economy has encouraged investors to continue selling dollars and move into alternatives such as, the Euro, the Yen and Commodities.
Recent evidence showed that there was a sharp drop in US retail sales during February. Combined with falling house prices, the once mighty, American consumer is now showing signs of a sharp drop in spending. With Consumer spending accounting for the majority of domestic demand, this fall makes the prospect of a deep recession more likely. Therefore, the Fed may be forced to lower interest rates further making dollar holdings even less attractive.

Negative Factors Affecting the Euro

1. Peg to the Dollar.

Many asian economies have pegged their currencies to the dollar. However, the continual fall in the dollar makes this a problematic experience. Countries such as Vietnam and China are experiencing increasing inflation because their currencies are undervalued (making imports expensive). As a consequence, many Asian economies are considering abandoning their link to the dollar. This would allow their currencies to appreciate and would cause the dollar to fall further.

2. The Bandwagon effect

The other worry is that the decline in the dollar may become a rout because the falling value may encourage a bandwagon effect as investors just sell their positions to get out of a falling asset. Asian investors have huge levels of American dollar holdings; it is a big cause for concern if these positions start to be sold.

Reasons Why Euro may be overvalued.

3. Is the Euro Strength Justified?

The remarkable rise of the Euro should not be seen as a ringing endorsement of the EU economy. Its rise is mainly due to the fact that it's not the dollar. The Euro area includes many countries experiencing particular problems. Countries like Greece and Italy have public debt of over 100% GDP. So far the Central Bank has been resolute in keeping interest rates at 4%. However, the credit crunch and global slowdown could increasingly harm the Euro economy and motivate the ECB to cut rates. If this occurs the Euro starts to look overvalued. On a basic level, a European consumer on holiday in America can hardly believe how cheap American goods are; this reflects the fact that exchange rates have become detached from living costs.

4. Will Central Banks Intervene?

Another likely occurrence is that the main central banks will start to intervene in currency markets. The ECB is concerned that the Euro's strength harms European exports. Similarly the Japanese fear that the appreciation in the Yen could cause significant problems for their faltering economy.


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