US Dollar Strength Uncouples Currency Train
Countries with fixed exchange rates pegged to the US dollar are expected to unhook their currencies as the American economy pulls ahead of the rest of the world.
Over the years, lots of central banks have pegged to the US dollar to stabilise their currencies.
The benefit for the non-dollar currency is the exchange rate does not change in the same way as a floating currency and makes trade and investment between the Us and other countries more predictable.
Pegged currencies are often favoured by smaller economies, but the signs are many are reconsidering their position with the dollar.
Countries such as Egypt, Nigeria, Saudi Arabia, Bahrain, Qatar, United Arab Emirates and Oman look at risk of devaluation as the US dollar keeps strengthening and the price of oil is weakening.
The Central Bank of Egypt has already announced a move to a floating exchange rate with the US dollar following a 13% devaluation.
Recently, Venezuela devalued the bolivar by just over a third in a bid to revitalise a stalling economy
Kazakhstan and Azerbaijan were among nations that unpegged from the dollar last year.
Greece saw the problems of remaining pegged to an exchange rate before the European Union bail out.
The problem with pegging is the strongest currency dominates the relationship and the only economic tools available to a government is devaluation – and when devaluation is not an option as in Greece’s case due the government’s tie to the single market currency, then the economy can collapse.
Cost of uncoupling
Unpegging does come at a cost to a government’s foreign exchange reserves and rising inflation.
The benefits are cheaper exports but more expensive imports, which should trigger internal demand.
The recent minor increase in the price of oil has helped Middle Eastern countries delay unpegging, but in the long run analysts see the move as beneficial to their economies.
“Oil bouncing back has helped,” said Piotr Matys, emerging market foreign exchange strategist at Rabobank. “Most analysts would doubt if the oil situation is sustainable and sooner or later, it’s likely oil producers will have to let go of the US dollar and free float.”
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