Dollar Weaker on Interest Rate Speculation

The U.S. dollar was down 0.7 percent in mid-day trading in New York today on reports that first quarter growth was less than expected. The latest employment news also indicated that 424,000 new unemployment benefit claims were filed last week exceeding predictions by more than 10,000.

The weaker-than-expected results gave rise to increased speculation that the Federal Reserve will continue to lag other Central Banks with respect to interest rate increases. Last month, the European Central Bank lifted the benchmark lending rate by a quarter point to 1.25 percent thereby ending a stretch of nearly two years of holding the line on rates. The Fed has maintained its record low 0.25 percent rate even longer and few expect an increase prior to the end of the year.

ECB President Jean-Claude Trichet added to the dollar’s troubles earlier today when he noted that the Bank was particularly concerned that rising commodity prices could lead to inflation and that the Bank would continue to monitor prices. Readings on this vary, and while it may not mean that rates will necessarily rise at next month’s meeting, it is clear that inflation is near the top of the Governing Council’s list of concerns.

At the very least, it is widely accepted by market observers that the ECB will move to raise interest rates long before the Fed makes a similar move. This reading of the situation – combined with the weaker U.S. employment and consumer spending data – is why the euro has gained ground on the dollar today. This advance comes despite concern over the fate of the shared currency in light of the European debt crisis.

Euro Still Dogged by Credit Crisis

Even as the euro gains on the dollar, it continues to lose against other currencies. In May alone the euro has lost nearly five percent to the yen on fears that the situation in Greece could deteriorate to the point that billions in debt could require restructuring. This really is unchartered territory and no one can say with certainty how markets will react should investors be forced to extend maturity dates or accept lower payouts as part of a restructuring.

Not helping matters is the growing public backlash against the so-called austerity programs ordered by the European Union and the International Monetary Fund in return for emergency funding. Greece has been plagued by large riots since government spending cuts were first announced and now opposition parties in Spain have said they will refuse to support the government in its attempts to trim the deficit.

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