Monday, February 09, 2004

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Outcome of Boca Raton G7 Meeting

Published Date: February 9, 2004

G7 Clarifies Dubai Message - No Major Shift to Policy

In the G7 - What to Expect article that we released last week, we predicted that there would no major shift in policy at this past weekend’s G7 meeting. Taking a look at the statement released by the G7 finance ministers and central bank governors, we see that G7 officials used the most recent communiqué to clarify the message that they released in Dubai last year.

The following is the communiqué’s paragraph on FX:

“We reaffirm that exchange rates should reflect economic fundamentals. Excess volatility and disorderly movements in exchange rates are undesirable for economic growth. We continue to monitor exchange markets closely and cooperate as appropriate. In this context, we emphasize that more flexibility in exchange rates is desirable for major countries or economic areas that lack such flexibility to promote smooth and widespread adjustments in the international financial system, based on market mechanisms.”

Aside from the two new lines in bold, the statement remains identical to the one released in Dubai and effectively clarifies the Dubai message, reflecting a compromise between the US, Europe and Japan. To Europe and Japan’s content, the first line added was “excess volatility and disorderly movements in exchange rates are undesirable for economic growth.” These are the same words that European officials have been repeating since the euro broke above 1.25 and reflect the G7’s concession to acknowledging the abrupt weakness of the dollar. The second new line (that lack such flexibility) is clearly directed at Asia. Without directly naming names (in particular, China), the G7 is calling for Asian countries to bear an equal burden of the dollar’s slide. Although this line may also appear to be directed at Japan, Japanese Finance Minister Tanigaki clarified the message over the weekend, saying that the G7 message was not targeted at Japan. The Japanese yen has fluctuated just as much as the EUR has since September, therefore “Japan is NOT one of the countries that are lacking flexibility and that was understood at this G7 meeting.” He also added that, “every G7 country agreed that Japan’s currency regime is flexible.” For the US, the statement retained the “flexibility” message and does nothing to suggest that the G7 wants to reverse the dollar’s decline.

Growth

The G7 statement was also very upbeat in terms of global growth. In contrast to the Dubai statement which started with “recent data indicate that a global recovery is underway,” the Boca Raton statement said that “the global economic recovery has strengthened significantly since our meeting in Dubai and risks have diminished.” The individual press conferences given by the G7 finance ministers and central bank governors also reflected this collective optimism. However, the G7 still feels that “much more remains to be done,” which suggests that member countries will be engaging in more pro-growth policies.

Dollar Downtrend Remains Intact

Therefore in no way does this statement change the direction of the dollar or put a floor under the dollar. The G7 wants the market to focus on the pace and distribution of the dollar’s decline - making sure that currency movements do not become excessive and calling for a more pronounced correction in the dollar against the Asian currencies.

The statement also indicates that the Europeans may not be completely uncomfortable with the current direction of the dollar - instead they want time to absorb and adjust to the dollar’s slide and corresponding euro rise. As indicated by recent European and more specifically German economic data, the negative effects of the gains in the euro has been limited thus far. Therefore 1.30/1.35 is still a possibility for the Euro.

Japan also staunchly defended their intervention policy at G7, arguing that the JPY has already shouldered a major part of the dollar correction. The statement contains no limitations or harsh words for Japan - which means that the Japanese will continue to cap gains in the JPY. Therefore although we believe that the long term USDJPY downtrend should remain intact as fundamentals prevail, in the short term, we expect to see repeated attempts by the Ministry of Finance to send USDJPY higher.

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