War in Iraq strengthens US dollar

Euro

The week started with US dollar softening across the board after the US President George W Bush gave the United Nation one more day to find a diplomatic solution to the Iraqi crisis before resorting to military action.

Financial markets sold the greenback in search of safe haven currencies pushing the euro and other major currencies higher. Traders sold dollars on views that a US led war without much international support would leave the US footing most of the bill for the conflict and would discourage US investment flows, both of which would hurt the US economy.

The dollar gyrated wildly after US President GW Bush warned Iraqi President Saddam Hussein and his sons to leave Iraq within 48 hours deadline to avoid war, fuelling expectations that the conflict was imminent. As the clock started ticking, the US dollar rallied higher on expectations that a US led war in Iraq would begin soon, and on speculation that it would end quickly. As the deadline came closer the greenback steadied and traded in razor thin range as the market held its breath for the launch of an attack.

While the market was focussed on Iraq, the US Commerce department reported that groundbreaking on new U.S. homes slowed in February to the lowest level since last April, with demand curtailed by harsh winter weather. The market shrugged off the US Federal Reserve's decision to keep the Fed fund rate steady at 1.25 percent.

The Fed.'s unexpected decision to not give an assessment of economic risk, on the grounds that it is too difficult to characterise, raised some eyebrows in the market. The Fed said it would practice 'heightened surveillance' until uncertainties in the economy abated, language that economists said did not preclude an intermeeting rate cut but did not necessarily signal one either. In the euro zone, data showed the region's consumer prices rose faster than expected in February, taking the annual inflation rate to a 11-month high of 2.4 percent.

The opening salvo of war against Iraq dented the dollar's momentum on Thursday, with dealers selling the dollar against major currencies as they mulled the potential for a long drawn-out conflict.

Early Thursday morning, U.S. President George W. Bush ordered American and British forces to begin bombing select targets in Baghdad, the first stages of what he termed 'a broad and concerted campaign' to topple Iraqi President Saddam Hussein.

Although the U.S. currency immediately set new two-month highs against the euro and Swiss franc, it pared those gains as concerns grew among dealers that the war could be protracted and may involve heavy casualties. In his speech from the Oval office, Bush cautioned that the looming battles 'could be longer and more difficult than some predicted.'

Currency markets turned extremely choppy after the assault started, with the value of the dollar rising or falling depending on perceptions of how well the war was going for the United States and its allies.

The start of a massive aerial bombardment of Iraq called the 'shock and awe' campaign by the Pentagon, and reports that US and British forces had taken the key port of Umm Qasr strengthened the belief among traders that the conflict would be short-lived. The dollar soared to the day's highs on reports Saddam Hussein may have been killed in the initial salvo against Baghdad in the wee hours of Iraq's morning on Thursday. Officials later cast doubt on the reports.

In Europe, Germany, France and Italy, already on course to breach the European Union's budget rules as their economies stagnate, now have justification for letting their deficits widen: the war in Iraq. War poses an ''exceptional'' risk to the economy that allows a temporary easing of restrictions on deficits, EU Monetary Affairs Commissioner Pedro Solbes said at a meeting of European leaders in Brussels that concludes today.

The 12-nation euro economy, of which France, Germany and Italy make up three-quarters, may shrink in the first quarter, the EU predicts. The German economy has barely grown since sinking into recession in 2001. French exports fell to the lowest in more than a year in January.

By the end of the week, US stocks rallied, sending the Dow Jones Industrial Average to its biggest weekly gain in more than 20 years, as the US and UK attacked Baghdad by air and their ground troops moved into southern Iraq. For the week, the Dow climbed 8.4 percent, its largest gain since the five days ended Oct. 8, 1982.

The S&P 500 rose 7.5 percent for the week, while the Nasdaq added 6 percent. Year-to-date, the Dow has risen 2.2 percent and the S&P 500 has added 1.8 percent amid optimism the war will end in days or weeks and spark a recovery in consumer and business spending. The Nasdaq has gained 6.5 percent. Oil prices sank to four-month low amid growing hopes for a swift conclusion to the war as US British forces raced towards Baghdad.

Range for the week: $1.0000 - $1.1000

Japanese yen

Japanese yen started the week on a cautious note, as Japan's own economic worries and wariness of yen selling intervention limited yen appreciation.

Speculation has lingered that Japan could conduct large-scale intervention, especially as the Nikkei stock average hit a 20-year low last week. Japanese authorities wants a weaker yen to help exports, one of economy's few bright spot.

Bank of Japan Governor-designate Toshihiko Fukui told a parliamentary committee he would allow a weaker yen, fuelling speculation Japan will sell yen for a third month to halt a 10 percent rally in the past year that has crimped export.

Strong dollar buying by Asian central banks, anxious to keep their currencies competitive at a time of weak export demand, and the constant threat of intervention by Japanese authorities are seen as strong positive factors for the U.S. dollar. Analysts said Asian central banks, especially the Bank of Japan, have had a major role in rise of the dollar from early March lows of around 116.35 yen.

Federal Reserve's statistics show foreign central banks bought around $30 billion of Treasuries since mid-February. Analysts also believe the new BOJ Governor Toshihiko Fukui, who started his new job on Thursday, was likely to pursue an even more expansionary monetary policy than his predecessor. That could include targeting a weaker yen to boost Japan's exports, and raise import prices to help fight deflation.

Vice Finance Minister for International Affairs Zembei Mizoguchi said after the attacks on Iraq started that Japanese authorities would take appropriate action to avoid turbulence and excessive moves in the foreign exchange market.

Finance Minister Masajuro Shiokawa said Japan would work with other G7 major industrialised nations if the war led to major disruptions in the world economic order, although he said Japan had not yet been in contact with other G7 nations. The European Central Bank said it stood ready to act if necessary in financial markets to assure 'sufficient liquidity provision' during the uncertainty.

Range for the week: 118.00 - 125.00

Sterling

Sterling remained under pressure, hitting its lowest against the dollar in over three months, after British Prime Minister Tony Blair suffered the biggest party revolt in modern history.

Blair won parliamentary backing for war against Iraq but about one in three members of his Labour Party rebelled against him. Blair's decision to support a war on Iraq without United Nations' backing has already prompted the resignation of three government ministers, including the high-profile former foreign secretary Robin Cook.

With so much attention focussed on Iraq, data showing British inflation surged to its highest in nearly five years in February made few ripples in the currency market. Official figures showed underlying inflation rose by 3.0 percent year-on-year in February up from 2.7 percent in January. Market analysts said the jump is unlikely to stop the Bank of England cutting interest rates again.

Minutes of the Bank of England's Monetary Policy Committee meeting of March 5-6 showed the MPC voted 8 - 1 to keep interest rates steady at 3.75 percent. The MPC said the immediate outlook was for growth to be a little below trend and for inflation to be above target.

It also said the fall in sterling combined with signs the housing market and consumer demand were beginning to slow might help in rebalancing the economy, though the pound's decline was also advanced as an argument for raising interest rates.

Range for the week: $1.5100 - 1.5800