By Stephen Halmarick,
Senior Economist, Citi Economic and Market Analysis
The US economy has been struggling with severe economic headwinds for a longer period of time than most others, and thus could be the first to emerge from recession.
Supporting that view is an aggressive monetary policy and what is expected to be a vigorous fiscal stimulus plan.
Measured against the US, the Euro Zone policy response has been tepid, and, if not made more aggressive, could prolong the recession, putting pressure on the euro, especially in relation to the dollar.
We do anticipate, however, that the euro probably will continue to appreciate against other European currencies.
Sterling is likely to remain weak well into 2009, reflecting the UK’s severe recession, ballooning fiscal deficit and falling policy rates. A weak pound will help underpin exports and offer useful support in the face of shrinking domestic demand.
Of course, there is a potential boost to inflation from a weaker pound, but in our view, that should be offset by the squeeze on margins from the recession and collapse in commodity prices.
Yen in unique position
We expect the Japanese yen to retain its unique position in the currency market in 2009.
It will likely continue to appreciate against the US dollar through the year, as uncertainty persists surrounding the global economic outlook and volatile financial markets.
However, economic spillover from a strong yen will likely be capped by Japan’s Ministry of Finance. The government will probably intervene in the currency market if the yen appreciates against the US dollar in a way that takes a significant toll on the economy and financial markets.
Asian currencies ex Japan generally weakened in the final weeks of 2008 on reduced risk appetite, slowing growth and deteriorating current accounts. The Korean won, the Indonesian rupiah and the Indian rupee led the decline due to their external financing risks.
Even the Chinese yuan, having appreciated rapidly against the dollar earlier in 2008, has stagnated of late. Once global financial risks subside, we believe the yuan will likely resume a path of around 5% annual appreciation against the greenback.
Downward dollar shifts
The Australian dollar will likely trade with a downward bias in the near term, as global commodity prices continue to decline, policy rates are cut and risk appetite remains impaired.
Further into 2009, however, we expect the Aussie dollar to recover some of its lost ground, especially if China can avoid the worst of the global downturn and the Australian financial system remains in better shape than many of its peers.
The Canadian dollar has retreated sharply with the slide in commodity prices. US dollar strength, spillover from ongoing global financial market imbalances, monetary policy easing and downbeat Canadian data reports have also weighed heavily on the loonie. There is nothing in the outlook that will change that anytime soon.