Decline of European Currencies Against the Dollar and Yen

Investor concerns in global foreign exchange markets that European central banks may refrain from further interest rate hikes due to the spreading crisis in the U.S. mortgage market last week resulted in a significant decline in the exchange rates of the euro and the British pound against the dollar.

Thus, the euro weakened by 1.6 percent against the dollar, to 1.3475 dollars. During trading, it fell to its lowest level in the last two months at 1.3383 dollars. The British pound weakened by two percent, to 1.9814 dollars, marking its lowest exchange rate since spring. At the same time, the Swiss franc dropped by 0.8 percent, to 1.208 francs per dollar.

"The dollar continues to gain against the pound and the euro as investor concerns grow about the actual strength of European economies," said James Hughes, a market analyst at London’s CMC Markets. He also noted that speculation is increasing that the Bank of England and the European Central Bank may hesitate to raise interest rates further.

Both central banks kept their interest rates unchanged at their last meetings. Thus, the key interest rate in the UK remains at 5.75 percent, and in the eurozone at 4.0 percent. Recently, the U.S. Federal Reserve also kept its key interest rate at 5.25 percent. Generally, markets are nervously awaiting any new evidence that problems from the U.S. subprime mortgage market are spreading to the overall economy, prompting investors to withdraw money from riskier assets into safer ones, namely currencies with lower yields.

In such conditions, the exchange rate of the New Zealand dollar, which carries an interest rate of 8.25 percent, fell the most sharply. Its exchange rate dropped by 2.4 percent against the greenback, standing at 0.632 U.S. dollars. Moves by the largest central banks in the world aimed at increasing liquidity in the banking system have somewhat helped calm financial markets affected by nervousness due to significant losses of banks and funds related to the crisis in the U.S. subprime mortgage market. Over the past week, they injected a total of more than 300 billion dollars into national banking systems.

In an effort to calm the market, U.S. Treasury Secretary Henry Paulson stated on Thursday to the Wall Street Journal that large price fluctuations in financial markets would harm U.S. economic growth, but that the financial system is strong enough to withstand these losses without pushing the economy into recession. The president of the Fed in St. Louis, William Poole, said there is no need for an urgent cut in interest rates. However, on Friday, U.S. monetary lawmakers unexpectedly lowered the discount rate by half a percentage point to 5.75 percent in an effort to ensure a sufficient flow of credit to the economy.

Meanwhile, the yen’s exchange rate rose to its highest level against the dollar and the euro in nearly 10 months. Thus, the dollar traded at 113.2 yen, or 3.4 percent less than the previous week. The euro fell at one point to 149.28 yen – the lowest level since early November last year, closing the week at 154 yen. Such a strong surge in the yen’s exchange rate has sparked speculation that Japanese monetary authorities may intervene in the market by buying dollars, which they last did in March 2004. At that time, it grew into a campaign lasting 15 months, during which 35 trillion yen or 305 billion dollars were invested.

"Institutional investors are liquidating assets to protect themselves, resulting in purchases of yen. This increases the likelihood that the Bank of Japan will intervene; everyone is aware of this," said Hans-Guenter Redeker, chief currency strategist at BNP Paribas. (Hina)