Prospect of further rate increases may buoy USD

Initial reactions to Hurricane Katrina were focused around the devastating impact it would have on the economy and whether the Federal Reserve would forestall its planned monetary tightening. Now that economists have had adequate time to asses the hurricane, the consensus is that the macroeconomic impact will be negligible, and in any event will be offset by inflation. As a result, two regional Federal Reserve Presidents hinted that the Fed would continue to raise interest rates, with a consensus year-end forecast of 4.25%. This will further drive interest rate differentials between the US and other industrialized nations, and underscore support for the USD. The Financial Times reports:

“While initially viewed as a supply-side shock that would raise the odds of a US recession, the popular consensus now argues that Katrina will promote an easy fiscal/tight monetary policy mix that will prove dollar supportive.”

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