Recent fluctuations in the dollar reflect market speculation about potential changes in central bank monetary policy. The markets have concluded that the European Central Bank and the Bank of England will raise interest rates by June. The odds are high that they will be correct. As a result of some benign inflation data, the markets are again speculating that Ben Bernanke, chairman of the Federal Reserve, could ease monetary policy. There is in fact little prospect that the Fed will change US monetary policy before 2008.

The US dollar is always vulnerable to perceptions of economic weakness and monetary easing because of America’s large current account deficit. The US needs $60bn-$70bn of capital inflows every month to fund the deficit. Many prominent American economists believe the dollar must fall by 30-40 per cent if it is significantly to reduce the current account deficit. The problem with the dollar pessimists is that they continuously underestimate the ability of the US to import capital.