THE dollar took a pounding on foreign exchange markets yesterday, with the euro breaking above $1.20 for the first time as sterling surged to a fresh five-year high.

The record US current account deficit, the resurgence of American protectionism and thin Thanksgiving holiday trade all combined to send the dollar sliding.

European currencies benefited most from the US currency’s fall, with the euro setting a record high and the pound rising still further above the $1.70 mark. The euro surged as far as $1.2015, while sterling closed in London at $1.7201. In New York the pound also closed higher at $1.7215.

The City is divided about where the dollar will go next. Some analysts forecast further steep climbs in the value of the pound against the dollar if traders can break through the technical barrier of $1.7366 — a decade high.

Others, however, believe that the dollar correction is nearly over. The US currency has lost as much as 20 per cent against the euro in recent months, and has also fallen steeply against the pound.

Stephen Jen, currency strategist at Morgan Stanley, the US investment bank, said that although the dollar remained modestly overvalued, the adjustment process was almost complete.

For British business, the rise in the pound against the dollar is a mixed blessing. For those UK companies that export to America, the leap in the pound will undermine competitiveness. With exports to Europe also suffering because of the lacklustre recovery on the Continent, this will further increase the pressure on the fragile internationally exposed sector in the UK.

Those UK companies with sizeable operations in America could also see their profitability hit by the jump in the pound. Just as the weak euro reduced the reported profits of sterling-quoted companies in the late 1990s, a similar “currency drag” could come into play in the next reporting season if the dollar remains depressed. But the dollar decline could bring a sizeable windfall for many companies that import raw materials and semi-finished goods from America.

Also winning will be companies that use commodities such as oil in production processes. This is because, in common with many internationally traded commodities, oil prices are denominated in dollars.

Continuing imbalance in the US economy, in particular a record current account deficit that has been swollen by surging consumer imports, is the key economic fundamental dragging the dollar down.

Andrew Delano, currency strategist at IDEAglobal in New York, said: “Everybody is looking at the current account deficit. People see US growth stronger than its trading partners’ and it becomes obvious that . . . the brunt of the adjustment is on the dollar.”

Technical trading factors also hastened the dollar’s fall. Volumes were thin because of the Thanksgiving holiday, meaning that the dollar was particularly volatile. The expiry of currency options contracts added to selling pressure.

Fear of intervention by the Bank of Japan also deterred traders from selling the dollar/yen cross too aggressively. This meant that the bulk of dollar selling was against the European currencies.

Data released yesterday showed that the Bank of Japan (BoJ) spent 1.5996 trillion yen (£8.6 billion) selling its own currency and buying the dollar during November. Japan has spent almost Y18 trillion this year in supporting the value of the dollar against the yen.

Analysts said that the primary reason was to stop the yen rising too far and undermining the struggling export sector. However, the BoJ has substantial dollar-denominated assets, and is said to be unwilling to let the currency slide too far.

Effects of the weak greenback

American tourists will postpone or cancel holidays in the UK.

Source: CBI