The dollar tumbled against the euro and the pound yesterday as the markets tested whether the Group of Seven's finance ministers were prepared to back up their condemnation of currency volatility with firm action.
The euro, which dipped initially after the G7 statement, later raced as high as $1.2761 closing in on its all-time high of $1.299 while sterling offered the biggest drama, scoring an 11-year high of $1.8628.
Traders brushed aside the wording of Sunday's communiqué, interpreting it as a compromise between the United States' demand that the dollar be allowed to fall and the Europeans' demand that other countries especially China share the burden of the devaluation.
Analysts said the euro would continue to rise until the G7 or the European Central Bank on its own was forced to act by intervening on the money markets or cutting interest rates. "The market is likely to want to know where are the 'teeth' to support the statement," said one trader.
The G7, which triggered a 12 per cent fall in the dollar after it used its September meeting to call for flexible exchange rates, tightened up the language to send a clear signal to Asian countries that operated a currency peg with the dollar.
Ministers from the G7's eurozone members France, Germany and Italy secured a call in the communiqué for countries that lacked flexibility to promote smooth and widespread adjustments. The communiqué also said: "Excess volatility and disorderly movements in exchange rates are undesirable for economic growth."
But economists said that with little sign that China which is not a member of the G7 was planning to abandon its peg, further falls in the dollar would mean further rises in the pound, euro and yen.
Julian Jessop, the chief international economist at Standard Chartered bank, said the statement from the G7 was consistent with continued dollar weakness against the euro and the yen as long as it is gradual. "There has been no change in the key fundamentals undermining the dollar," he said.
Paul Ashworth, the international economist at Capital Economics, said the euro would hit a high of $1.40 by the end of the year, preventing anything more than a modest economic recovery in the eurozone. He said the ECB would have to cut rates to 1.5 per cent in the summer as the euro's strength cut both growth and inflation.
Traders will turn their attention to Alan Greenspan, the Fed chairman, who testifies on monetary policy before the Congress tomorrow.Reuse content