The euro remains under pressure, reflecting a shift in sentiment about the outlook for the euro-zone economy.
The single European currency has moved steadily lower against the dollar in recent weeks, rattling the world foreign-exchange market.
I predicted a month ago that the yen’s strength cannot be sustained for long.
My prediction was based on the assumption that a strong yen fueled by optimism about the administration of Prime Minister Junichiro Koizumi would be a one-time event.
The prediction has turned out to be wide of the mark, however, with the falling euro helping shore up the yen.
A key downside factor for the euro is an economic slowdown coupled with rising inflation in the euro zone.
Industrial output fell faster than expected in April and inflation jumped to 2.9 percent, well above the European Central Bank’s 2 percent target.
The economic exacerbation has offset the positive effects of tax cuts enacted earlier this year, raising fears that already-beleaguered households will be still worse off in the coming months.
The ECB lowered its refinancing rate last month, but inflation fears are inhibiting it from cutting the key rate again, and its refusal to ease its grip on credit further has come back to haunt the economy. Still, the ECB viewed the inflation surge as a one-time event, expecting the economic slowdown to keep inflation from getting out of hand.
Although a weak euro has made crude oil costlier to obtain in the euro zone and food prices have soared in the wake of the farm crises caused by foot-and-mouth disease, in the ECB’s view, the surge in inflation will subside in the second half of the year.
This view could soon prevail in the marketplace, too.
It is now widely considered a foregone conclusion that the ECB will have little choice but to lower the refinancing rate again in a month or two.
With inflation fears fading and speculation about an interest rate cut out of the way, the euro could begin gaining ground against the dollar and yen later in the year.
Worries about a flight of money out of the euro zone could then be put to rest, helping shore up the euro.
The dollar’s fall against the euro could then drag down the yen along with it.
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