US economy buoyant as dollar passes 110 barrier

The dollar hit its highest level against the yen for two-and-a-half years yesterday, passing the psychological barrier of 110 as the Federal Reserve began a two-day policy meeting.

Even though most analysts do not think the Fed's open market committee will raise US interest rates after the meeting ends today, the strength of the economy means the next move is likely to be an increase.

Further evidence of the buoyancy of the American economy was provided yesterday by a surge in new house sales to the highest level since April 1986. They jumped 7.5 per cent in May, following a 5.9 per cent increase in April.

In addition, the index of leading indicators rose 0.3 per cent in May. This was the fourth increase running in the index, which is meant to signal the strength of activity during the next six months.

However, Fed officials have been signalling that it is too early to be alarmed about the resurgence in growth, as inflation remains firmly under control. Most of Wall Street therefore expects the increase in interest rates to be postponed, possibly until after November's presidential election.

The Bank of Japan's quarterly meeting gave the US currency a further boost, ending yesterday with a signal that Japanese interest rates would not yet climb from their all-time low.

Bank of Japan Governor, Yasuo Matsushita, said: ''The recovery needs to gain further momentum and spread wider to become self-sustaining."

Traders said nerves about the outcome of today's second round of voting in the Russian elections was also helping to strengthen the dollar.

A minority of City economists believe there is a chance that the Chancellor Kenneth Clarke will reduce British base rates by a further quarter point after this morning's meeting with Eddie George, governor of the Bank of England.

Although it is only a month since the last cut, by a quarter point to 5.75 per cent, evidence that the economy is gathering pace could make it harder to justify another reduction in the autumn.

"The Chancellor has got the bit between his teeth," said Geoffrey Dicks, UK economist at NatWest Markets.

The pound, nevertheless,strengthened alongside the dollar yesterday in London and it rose by more than half-a-pfennig to end at DM2.3762.

According to market rumour, there has been a lot of speculative buying of the pound in recent weeks. However, Bronwyn Curtis, an economist at Deutsche Morgan Grenfell, said there was also a genuine switch by investors in favour of sterling.

The currency moves follow the weekend's communique from the Group of Seven finance ministers, describing recent exchange rate developments as "positive and promising". It said exchange rate misalignments were "detrimental to trade and growth".

This left the currency markets puzzling over whether the ministers sought a further climb in the dollar's value against the yen.

The dollar has gained nearly 2 per cent against the Japanese currency in the past month, and is 36 per cent above its April 1995 record low of 80.63.

The dollar ended at 110.39 in New York, up from the previous day's 109.68. The Dow Jones index closed 9.6 points lower at 5720.38.

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