It is tempting to see cause and effect in the European Central Bank's currency-market interventions ...
It is tempting to see cause and effect in the European Central Bank's currency-market interventions in September and November and the euro's climb to a six-month high against the dollar the first week of January.
Resist that temptation. The introduction of the 'r' word into sentences describing the outlook for the US and Japanese economies furnishes a complete explanation for the euro's crawl from the October 26 low of 82.31 US cents to 5 January giddy height of 96 cents. No belief in the power of intervention is required.
Central banks don't change investor attitudes towards a weak and unwanted currency. Economies do. And investors typically steer clear of the currencies of regions facing recession, instead favouring those that don't. The ECB intervened on four separate days last year. It had the help of its Group of Seven central bank buddies for the first bout of intervention on September 22, with three solo efforts following in the first nine days of November.
The best level the common currency could manage during that period of central bank purchases, however, was 89.92 cents, with an average rate of 85.89.
Japan spent almost $80bn between January 1999 and April 2000 in a failed effort to halt the yen's appreciation against the dollar. During that period, the yen strengthened to as high as ´101.46 per dollar from a low of almost ´125.
The Japanese currency's advance was only halted once investors grew concerned about the frailty of the mooted economic rebound. And it only changed direction once the economic evidence of a renewed slowdown became undeniable. Then the yen fell, reaching a 16-month low of 115.07 per dollar.
A survey of more than 50 analysts taken by Bloomberg News last month showed a consensus forecast for the euro to be worth 91 cents by the end of March, and 98 cents by the end of the year. About a quarter of those surveyed expect the euro to be worth at least $1 by the end of the year.
Run the same poll today, however, and you'd get an even more bullish prognosis of the euro's prospects. Why? Because, as my colleague Caroline Baum has often pointed out, price action drives sentiment, rather than the other way around. The trend is your friend, particularly if your forecasts for a strong euro have come undone for the previous two years. That doesn't mean analysts are wrong to predict a rosier euro outlook. Japanese officials aren't trying to stem the yen's recent decline because their economy needs all the help it can get, which will help boost the euro. The surprise interest rate cut from the Federal Reserve will amplify investor concern about the state of the world's biggest economy.
Moreover, the US might well decide to indulge in a little export-boosting benign neglect of its currency.
At a time when the US economy may be facing recession, don't bank on the new administration of President George W. Bush and new Treasury Secretary Paul O'Neill continuing to chant the Robert Rubin/Larry Summers mantra that "a strong dollar is in the best interests of the US economy."
Bush dodged that issue on 22 December. His response to a question on whether the tune will change was to say that his economic policy will be "one that is mindful of the need for this nation to attract foreign capital, capital which will continue to fuel what we all hope will be the entrepreneurial boom that has taken place over the last decade."
It's tough to imagine a US industrialist like O'Neill trying to talk the dollar up during a slowdown.
ECB officials spent much of last year telling the market that the euro was undervalued, and that the fundamentals would reassert themselves. That's exactly what's happened and would have happened even without the central bank attempting to bolster the currency by buying it.
Mark Gilbert in the London Bloomberg newsroom
Interest rate outlook unchaged
FCA made demands last week
'Unsung' part of FSCS work