The recent hullabaloo in global equity markets has overshadowed renewed dollar weakness against the euro. The US currency has fallen three cents in the past fortnight and is now almost 13 per cent below its level at the beginning of 2006. There is no need for alarm bells yet but the move certainly hints at a shift of thinking. In the past six months, the euro/dollar rate has closely tracked short-term interest rate differentials. Clearly, currency traders are now expecting European rates to rise relative to US ones – understandable given the raft of weak economic data out of the US recently and the continuing recovery across Europe. Fears that the US subprime lending crisis might spread will have strengthened this view. Indeed, US interest rate futures are now pricing in rate cuts of more than 50 basis points by the end of October.

There are other, familiar, reasons to be bearish on the dollar versus the euro. The US current account deficit hit a record 6.5 per cent of gross domestic product in 2006. In addition, more and more of the world’s central banks are talking about diversifying their foreign exchange holdings beyond dollar assets. The dollar is also losing its selling point as the foremost safe-haven currency. Even with the marked increase in volatility and risk aversion of late, there has been no real evidence of flight from euros to dollars. Europe’s currency has come of age.