Forex - Dollar recovery comes to a halt on US housing market collapse fears

9.01.2006, 01:05 PM

LONDON - The dollar's early afternoon recovery, in the wake of a solid US jobs report for August, came to an abrupt halt on mounting concerns that the US housing market is teetering on the verge of collapse.

The National Association of Realtors revealed that pending home sales slumped by 7 pct in July to their lowest level in three years. Its pending home sales index, based on contracts signed in July, fell to a seasonally adjusted 105.6 in July from a downwardly revised 113.5 in June.

Paul Ashworth, senior US economist at Capital Economics, said outright falls in house prices would appear to be unavoidable if this trend continues.

'Housing is in freefall and that is the key to the economic outlook,' he said.

'There are now clear downside risks to our longstanding forecast that GDP growth will slow to 2.0 pct next year,' he added.

The housing market has been the main reason behind the US growth spurt over the last couple of years and any suggestion that it is in trouble stokes up concerns about the economic outlook and the likely path of US interest rates.

Earlier in the afternoon, dollar investors had been comforted by a solid US jobs report, that allayed fears that the country is experiencing a sharp slowdown.

Though the US economy added an expected 128,000 jobs during August, jobs growth in June and July was higher than previously estimated and the unemployment rate dropped a notch to 4.7 pct. In addition, monthly wage increases were 0.1 pct, less than the 0.3 pct predicted by economists.

Analysts said the latest snapshot, released by the Labor Department, was consistent with predictions of moderating, but not collapsing, economic growth and unchanged policy from the US Federal Reserve. The Fed kept its key Fed funds rate on hold on Aug 8 at 5.25 pct after 17 consecutive quarter-point increases.

That expectation of a soft landing has helped US equities post solid gains ahead of the long weekend in the US.

'The dollar gained a little bit after the payrolls as the mix is in keeping with the asset market's soft landing scenario,' said Ian Stannard, currency strategist at BNP Paribas.

However, he said the recovery is unlikely to last and this afternoon's US pending home sales data augurs badly for the soft landing expectation if repeated over the coming weeks

In contrast to the Fed, most expect the European Central Bank to lift borrowing costs in both October and December.

Analysts said the expected narrowing of yield differentials between the US and the euro zone has helped the euro push up towards the 1.30 usd mark.

In his press conference yesterday following the much-anticipated decision to keep refi rate on hold at 3.00 pct, the ECB president Jean-Claude Trichet stressed that the central bank will maintain 'strong vigilance' on inflation risks and reiterated his view that monetary policy in the 12-nation currency zone remains accommodative, despite the anticipated US growth slowdown.

Trichet also said further rate hikes -- the ECB has steadily raised rates from 2.00 pct since last December -- are warranted should the economic recovery continue. The first half of the year was stronger than anticipated by the central bank and that seems to have continued into the third quarter, he added.

Analysts said Trichet's assessment fits in with the market view that rates will rise a quarter point in both October and December, which would take the refi rate up to 3.50 pct.