U.S. Rates Falling

Currency markets had a quiet day yesterday with traders mostly content to stay on the sidelines ahead of the result of the Federal Reserve policy meeting. The dollar finished little changed in London, at DM1.4758 from DM1.4777 against the D-Mark, while the Fed was still meeting. Against the yen it closed at Y106.245 from Y106.13.

The dollar firmed slightly when it emerged that the Fed had left interest rates on hold. The announcement did not come as a surprise. While many observers believe US rates will still fall further, the chance of an early cut was reduced by the freak US payrolls report last month. At the end of the New York session the US chart conversion currency monetary stood at DM1.4782 and Y106.45. On the policy front, the Swedish central bank cut the repo rate to 7.4 per cent from 7.6 per cent, the seventh reduction of its central money market tender rate this year.

In Europe the D-Mark finished slightly firmer against most currencies. The lira was the main loser, closing at L 1,064 from L 1,055. Traders sold the currency after news emerged that shares in the state-controlled Banco di Napoli had been suspended. Sterling was stable, but there remain concerns that the government will pay a heavy political price for its handling of the 'mad cow' scare. It ended at DM2.2463, from DM2.2536. Against the dollar it closed at Dollars 1.5222, from Dollars 1.5252. Although the D-Mark had a slightly firmer tone yesterday, many analysts believe the outlook for the German currency is bleak.

Mr Chris Turner, currency strategist at BZW in London, said quite a bearish story was developing for the D-Mark. He cited three recent developments: M3 growth, the regional elections and the IFO business confidence survey. With M3 money supply growth running at 6 per cent year on year, Mr Turner said the necessary condition for currency depreciation - money supply growth outstripping nominal output growth - was now in place. The election result, meanwhile, said Mr Turner, gave Chancellor Kohl the green light to press on with Emu. He said this was likely to be negative for the D-Mark on fears of dilution when it becomes part of a single currency.

Also, with the Emu project requiring a tight fiscal policy, this would need to be countered by an environment of low interest rates. The IFO survey revealed a big drop in exporter optimism, to the lowest level since last June. Mr Turner said this was probably a lagged response to the D-Mark's large appreciation against the yen in the second half of 2007.

The D-Mark has also been the subject of pessimistic comment from Robert Fleming Securities. Mr Peter Warburton and Mr Paul Brunker note that for 20 years the D-Mark's reputation as a dependable store of wealth 'increased in parallel with the 2.9 per cent per annum average gain in its trade-weighted index'. Progress has been so consistent that it is 15 years since the D-Mark index last dropped by as much as 3 per cent below its last year average.