Dollar drops to four-year low against euro

With war looming closer than ever over Iraq, the US economic outlook continued to worsen yesterday, amid signs of even wider deficits, a downturn in the key service sector and further slippage by an already weakening dollar.

The indicators came as the Federal Reserve released its latest "Beige Book" survey, a downbeat assessment of economic conditions in the US central bank's 12 member districts. Conditions "remained subdued" in the first two months of 2003, it said, citing continuing weak consumer and business spending. Yesterday, for the first time in almost four years, the dollar hit the psychologically important level of $1.10 to the euro, after comments by John Snow, the new Treasury Secretary, that he was "not particularly concerned" by the slide in the currency. In the past year alone, the dollar has lost 21 per cent of its value against the euro, amid concerns over war, historically low US interest rates and the rising trade and federal budget deficits.

Mr Snow's remarks hinted that Washington might be giving up the Clinton era "strong dollar" policy ­ adhered to even by his outspoken Bush administration predecessor, Paul O'Neill. The aim would be to provoke a weaker dollar, which would boost US exports and reduce a trade deficit running at a record $435bn (£272bn) for 2002 ­ more than 4 per cent of GDP.

But the deficit is even larger, up to 5 per cent of GDP, if measured by the current account which also includes investment profits. Formal acknowledgement of a change of attitude could trigger a wave of dollar selling. This in turn could force the Fed to push up interest rates, currently at their lowest level since the Kennedy era, to attract the $1.5bn daily inflow of foreign funds needed to finance the external deficit.

The internal federal deficit outlook is no better. Mr Snow insisted yesterday the budget shortfall could be financed easily, given the overall size of the economy, without necessarily pushing interest rates higher.

But even partial passage of President George Bush's proposed $675bn tax cut package would push the deficit higher, as would a war with Iraq, whose first-year cost is put at a minimum of $60bn. Other estimates range to double or more that figure.

The Bush administration is already projecting record deficits for fiscal 2004 and 2005 of more than $300bn. War and a tax cut, however, could push that to more than $400bn in the current year, Congressional calculations suggest. Between October and January, the first four months of the current year, the deficit soared to $94bn, compared with an $8bn surplus in the same period of 2002/03.

The Bush team, its eyes already fixed on next year's re-election campaign, is operating on the assumption that the economy will pick up once the uncertainty over Iraq is over. But that is unlikely until the second half of 2003 at the earliest.

The expansion in the services sector slowed last month according to a new report yesterday. Little cheer is expected from the February unemployment figures, scheduled for release tomorrow. After a rebound in January, the headline jobless figure is likely to increase once more, from 5.7 per cent to perhaps 5.9 per cent, analysts predict.