The G7 officials meeting in London next month also think China should move towards a flexible exchange rate regime in the long term, but at this moment there is no pressing argument to pressure Beijing to revalue the yuan given low domestic inflation and dollar strength.
The dollar is strengthening but its not a problem in itself and the financial market is absorbing (the change). As long as it is an orderly adjustment, up or down, (there is no problem). The global economy is posting trend growth so FX moves are not having a big impact, the source said. We are going to assess how sustainable this dollar strength is and also whether there is a risk of a dollar reversal. The source added the economic fundamentals in the euro zone remained weak and that the weakness in the euro did not cause any discomfort to the European Central Bank.
The comments pushed the euro to sessions low versus the dollar at $1.1673. The dollar has risen more than 10% against the euro this year, due to expectations for steady rises in US interest rates, reversing a sharp fall which pushed the greenback to a record low of $1.3667 per euro in December 2004. The global economy has proved resilient so far to the rising oil prices, which hit a record high above $70 a barrel earlier this year, before coming off below $60 recently.
Since the last meeting in September basically there hasnt been a big change. Oil moves will be a topic but the financial impact from oil is contained so far. We will discuss whether this (contained second round effects) will continue to be the case, the source said.
At their last meeting in Washington in September, the group of rich nations welcomed the July 21 move by China to revalue the yuan by 2.1 percent against the dollar.
Everyone thinks China should move towards a flexible exchange rate regime in the long run. But at the moment the yuans effective exchange rate is rising because of the dollar strength, the source said.
Compared with the July level the yuans effective exchange rate is up by a few percent against a basket of currencies. The real test comes when the dollar falls. At the moment there is no pressing argument for revaluation also as inflation in China is showing no sign of overheating and the economy is performing well.
The source also noted the G7 will assess how the global economy will react to a move towards tighter liquidity. The Fed has raised interest rates in 12 consecutive quarter percentage point steps to 4 percent and markets bet it will keep tightening until it reaches either 4.5 percent or 4.75 percent early year.
The European Central Bank has kept rates on hold at 2% for more than two years but markets are betting the ECB may move as early as December to raise rates.
The Bank of Japan has also said the possibility of a change in the current ultra-easy monetary policy will grow over the course of fiscal 2006/2007 starting next April. Central banks are moving towards tightening. Whether we will have an ECB tightening we dont know but even with the 3 percentage points rise in the Feds interest rates the market is orderly, the source said.
On the euro strength, the source said: The euro zone is having an export-driven recovery so at this level (of the euro) there is no negative effect. Eurozone fundamentals are weak, even compared with Japan, so the euro weakness is not uncomfortable for (the ECB).