In its latest Global Forecast dated June 2 (ie after the French and Dutch referendums), the Economist Intelligence Unit expects the euro to be slightly weaker against the dollar than previously assumed, at an average USD 1.32 per euro in 2005 compared with the previous forecast of USD 1.35, reflecting dollar strength in recent months.
However, it adds that it continues to forecast a “substantial decline in the dollar in late 2005 and into 2006.”
The year-end rate for the dollar is forecast at USD 1.37 per euro in 2005 and EUR 1.39 per euro in 2006, compared with about USD 1.22 the day after the Dutch overwhelmingly rejected the EU constitution.
Fundamentals will out
“The significant structural problems that caused the dollar’s slide in the last three years remain in place and, once the outstanding carry trades have been unwound, are likely to resume pushing the dollar in the other direction,” it says.
Carry trades are those in which investors borrow in US dollars at low interest rates and lend the money on in other currencies at higher rates.
“Over time, foreign investors will become reluctant to buy further dollar assets. It will become harder to find high-yielding dollar investments, and foreigners will start to be concerned about their exposure to capital losses should the dollar depreciate. In any case, investment in the US by foreigners is increasingly occurring to the detriment of investment at home. This makes little sense for emerging regions such as Asia, where returns on domestic investment are high.”
Good outlook for growth
The outlook for world growth in 2005-06 is still described as “good”, as the rate of growth will be similar to that experienced in some of the best years of the 1990s, “but in comparison with the heady performance of 2004 still represents a significant deceleration”, says the EIU.
“The structure of growth is also changing, with domestic demand trends become increasingly important relative to external trade.” The EIU forecasts that world GDP growth (on a purchasing power parity basis) will slow from a rapid 5.1% in 2004 to 4.3% in 2005 and 4% in 2006.
Since May the growth forecast for Japan has been revised up to 1.3% (previously 0.9%), following the release of unexpectedly strong GDP data for the first quarter of 2005.
There has been a large downward revision to the Italy GDP growth forecast in 2005, to 0.1% (previously 0.9%), in the light of first-quarter GDP data that showed that the economy had contracted for the second consecutive quarter.
The forecast for US consumer price inflation in 2005 has been revised up to 3.2% (previously 2.9%) as high energy prices feed through into other sectors of the economy more rapidly than expected.
