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G7 view of exchange rates boosts dollar

The dollar gained ground after an early dip yesterday as financial markets absorbed the meaning of the weekend's communique on exchange rates from the Group of Seven (G7) industrial countries, writes Diane Coyle.

An upbeat annual report on the economy from the White House's Council of Economic Advisers confirmed the market sentiment that the underlying state of the US economy warrants a strong dollar.

The G7 statement said "major misalignments" in exchange rates which the ministers had decided to tackle in April 1995 had been corrected. This was seen as a signal that they would be unhappy if the dollar strengthened very much further against the yen and mark, but equally that they were not about to intervene in the foreign exchange markets.

The view that the dollar's recent appreciation reflects economic fundamentals was boosted by yesterday's Economic Report of the President, which saw no sign of recession on the horizon. "There is no foreseeable reason why this expansion cannot continue," it said.

The tone of the report, issued each February, was extremely optimistic. "The ability of the economy to sustain low unemployment and low inflation is the best it has been in years," it said, claiming that the rate of unemployment below which wages and prices would start to pick up had fallen and could decline further.

US unemployment has been below 6 per cent, the rate which economists used to think marked the start of the inflationary danger zone, for more than two years. The Council of Economic Advisers is in good company in its view that the so-called "natural" or "non-accelerating inflation" rate of unemployment has fallen.

The Council concluded that the economy's potential growth rate is higher than the 2.3 per cent average predicted for the next five years. "The administration does not think that 2.3 per cent real growth in the long term is the best the US can do. The outcome could be even better."