Week two of dollar hell ahead: Further falls predicted in bonds and equities Japanese PM's exit hits hopes of swift action by G7

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The Independent Online
CURRENCY dealers and the world's central banks were preparing to rejoin battle over the fate of the ailing US dollar yesterday, with the resignation of the Japanese Prime Minister at the weekend threatening to limit the scope for joint action by the Group of Seven leading industrial nations.

Tsutomu Hata's resignation will further slow the torturous talks between Japan and the US over trade. It means that Japan could also be in a weak position at the G7 summit in Naples on 8 and 9 July.

Dealers are predicting further falls in share and government bond prices this week, after London share prices slumped on Friday as the central banks lost the first round of their fight for the dollar. Around dollars 5bn was spent in a support buying operation for the US currency by 17 central banks, but dealers were only too happy to sell to them and the dollar fell back to pre-intervention levels.

The London stock market fell by about 5 per cent last week, with the FT-SE index of 100 leading shares closing around 18 per cent below its February peak at 2,876.6. Robin Aspinall, the chief economist at Panmure Gordon, believes the Footsie will fall as low as 2,300, but will end the year at 2,800. Roger Nightingale at WI Carr is among the most bullish analysts, predicting that the index will fall further, but then bounce up to 4,000 by the end of the year.

Central bank officials talked by telephone over the weekend to plan their strategy. But dealers are becoming convinced that central bank buying of the dollar will be futile unless it is accompanied by a sharp rise in US interest rates, perhaps timed to coincide with cuts in borrowing costs in Germany and Japan. Last Tuesday, the dollar dipped below 100 yen for the first time since the Second World War.

But Alan Greenspan, chairman of the US Federal Reserve, is thought reluctant to raise interest rates to help the currency because he believes inflation remains subdued and the pace of US economic recovery may anyway be slowing. Lloyd Bentsen, US Treasury Secretary, has merely hinted at further co-ordinated intervention.

Julian Jessop, international economist at HSBC Greenwell, warned that a rise in US interest rates could be counter-productive. The Dow and the US treasury market could weaken further, especially if the move looked half- hearted, and overseas selling of US shares and bonds would simply exacerbate the dollar's weakness.

'The interest rate increases that have already taken place have contributed to a marked slowdown in economic activity. Is it really worth crucifying the US economy over a 5 per cent fall in the trade- weighted value of the dollar since the beginning of the year?' he said.

A rise in US interest rates would be unlikely to have any immediate implications for British interest rates, although the futures market may well become more pessimistic about future changes.

The Chancellor is unlikely to give any clues about the next move on rates when he outlines the Treasury's latest twice-yearly forecast for the economy this week, updating the predictions made in last November's Budget. He is understood to have raised his forecast for economic growth this year from 2.5 to 2.75 per cent and to have cut his forecast for underlying inflation in the fourth quarter of the year from 3.25 to 2.5 per cent.

Cambridge Econometrics today forecast GDP growth of 2.8 per cent this year, before stabilising at 2.5 per cent in 1995 and 1996.

(Graphs omitted)

Gavyn Davies, page 25

Larry Black, page 25

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