Dollar dolours faze Footsie

THE dollar has defied gravity for so long that its fall now is almost a surprise. The question is whether a retreat will turn into a rout. The fallout reached London and pushed the Footsie below 5000 for the first time since October.

The greenback steadied last night, but its value against major currencies has fallen about 7% since January. Mind you, in the previous seven years, it rose 40%. Given that the US trade deficit has widened to a yawning £286bn, this year's drop can be seen as a necessary and welcome correction. A gradual unwinding of the dollar's long rise would be healthy.

In an ideal world, it would be accompanied by a flow of investment into Japan to assist its long-awaited recovery, and by a strengthening of the euro to take the heat off Britain's hard-hit manufacturers. The Bank of England could seize the opportunity to raise interest rates and cool off the housing market and the booming retail sector. That is the ideal 'soft landing'. The danger is that the flow of funds out of the US could turn into a flood. If so, the greed and sleaze in corporate America would be just as responsible as the trade and budget deficits.

The lessons of the Enron collapse have now sunk in. Big investors are jittery about more mini-Enrons emerging. The dramatic ousting of Tyco boss Dennis Kozlowski and the suicide of a top executive at energy trader El Paso Corporation have kept nerves on a knife-edge.

Such is the loss of confidence that healthy US economic growth figures earlier this week, suggesting a rapid 5.6% rise in the quarter to March, were overlooked. Merrill Lynch expects growth of 4% in the second quarter - faster than virtually any other major country - and says 'the US economy shows every sign of healthy recovery'. Strong manufacturing figures last night backed up this view, and gave the market and the dollar some support.

The weakness is the huge level of US debt. Some experts fear a credit bubble will burst in the huge US housing market, hitting twin mortgage giants Freddie Mac and Fannie Mae. Any wobbles at these could rock the system to its foundations.

Base rate dilemma
IF Britain's economy were confined to consumer spending and housing, the Bank of England's base rate might easily be 6%, not 4%. But the economy also includes business, which is cutting investment, and manufacturing, shrinking at close to 6% in a year.

Simultaneously riding these two horses - one racing ahead, one going backwards - is stretching the Monetary Policy Committee's jodphurs to the verge of embarrassment.

For months now, house price rises have been accelerating, with the big two lenders now reporting about 18% year on year. Retail sales increases have been careering along at 5.5% to 6%. The CBI says only a net 25% of retailers saw rises in May, down from 57% in April; but April included Easter.

Royal Bank of Scotland economist Ross Walker says 'spending growth may be slowing, but only from an incredibly robust 6% to around 5 1/2%'. Simon Rubinsohn at Gerrard says: 'It is too soon to suggest that the consumer is throwing in the towel.'

Both economists expect the MPC to hold its fire today. It slashed base rate from 5% to 4% after 11 September in a pre-emptive strike against recession. With the Office for National Statistics reckoning the UK's growth was at a standstill in the six months to March, the MPC may think it too early to start putting rates back up again. The ONS figures have been questioned because their calculation, very crudely, was that the UK's output grew 3.5% in money terms, but inflation was also at 3.5%, so real growth was nil. Had they taken a lower inflation figure, such as the latest retail price rise of 2.3%, growth would have been much higher. It would not be surprising if the figures were revised upwards at some stage.

If the MPC decides this is likely, it might raise base rates in another pre-emptive strike, this time against inflation. Anyway, rates are on the way up and Walker acknowledges that 'we are close to the turning point'.

Share markets, alas, are more like Lady Thatcher - not for turning. The bear market is entering its 30th month, and the Footsie is once again almost 2000 points below its end-1999 peak of 6930. But HSBC strategist Robert Parks says the market is still selling at 20-times expected earnings - earnings that may not grow at all this year. We are not out of the woods yet.