US dollar weakens despite Fed comments

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The dollar continued to weaken against European currencies on Tuesday in spite of a speech from Ben Bernanke, chairman of the US Federal Reserve, in which he appeared to head off talk of imminent US interest rate cuts by warning that inflation remained “uncomfortably high”.

The dollar, which had appeared to stabilise earlier in the day, resumed its slide after Mr Bernanke’s comments. The euro hit a 20-month high against both the dollar and the yen, while the pound rose 0.5 per cent to $1.9480. That brought it close to a peak of $1.9548 reached on December 2004, the highest level since sterling was ejected from the Exchange Rate Mechanism in 1992.

US Treasury prices concluded an up-and-down day by rallying during mid-afternoon trading after Mr Bernanke spoke. US equities also experienced choppy trading, opening lower and then closing modestly higher to erase some of their heavy losses on Monday. Equity volatility fell slightly.

Speaking in New York, Mr Bernanke reassured investors that the outlook for the US economy remained fair, and the slowdown to more moderate growth
was proceeding largely as expected.

He said incoming data would determine “whether further policy action against inflation will be required”.

The speech followed days of jitters in financial markets, with investors betting that US economic weakness would force the Fed to cut interest rates next year, undermining the dollar.

Earlier in the day, fresh US data showed house sales inching up, but year-over-year home prices falling. Consumer confidence was weaker and durable goods orders experienced a significant drop.

While investors have been troubled by recent US data, Mr Bernanke said the slowdown “appears to be taking place roughly along the lines envisaged in the Federal Reserve’s July report”.

His message was reinforced by Hank Paulson, US Treasury secretary, who told reporters in London the US economy was making a “successful transition” to a more sustainable rate of growth, and by the Organisation for Economic Co-operation and Development, which said the outlook for the world economy remained bright.

Releasing its twice-yearly outlook, the OECD said it saw signs of a smooth rebalancing of global economic growth, with faster growth in Europe partly offsetting the slowdown in the US.

Jean-Philippe Cotis, the OECD’s chief economist, said there were signs that the growth of global trade imbalances had now stopped, raising the chances of a benign outcome.

Attributing the recent fall in the dollar to signs of economic strength in Europe and elsewhere, he added: “Even a smooth adjustment of imbalances has to start somewhere . . . we are not yet in a position where the depreciation of the dollar suggests people are fleeing the US.”

Mr Bernanke said the drag on growth from the housing sector was likely to continue into 2007, with continued pressure on prices and activity from high levels of unsold inventory. He also noted some evidence of spillover effects in sectors closely linked to housing and autos.

But he said “outside of the housing and motor-vehicle sectors economic activity has, on balance, been expanding at a solid pace” and would likely be underpinned by healthy income growth.

The Fed chairman said that core inflation had “improved modestly since the Spring” but observed that inflation remains “uncomfortably high.”

Reporting by John Authers in New York; Krishna Guha and Eoin Callan in Washington; and Chris Giles, Tony Tassell and Scheherazade Daneshkhu in London

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