The spark: April’s G7 communiqué

Some analysts point to the April 21 Group of Seven (G7) communiqué as a trigger for the May and April U.S. dollar weakness. That trend could be the start of a new focus into the second half of 2006.

In broad terms, the announcement from the G7 nations (the U.S., Canada, Great Britain, Italy, France, Germany, and Japan) stated the strong global economic expansion continues into its fourth year and the outlook remains “favorable.”

However, the key segment of the communiqué that sent the forex market flying was a note on exchange rates: “We reaffirm that exchange rates should reflect economic fundamentals. Excess volatility and disorderly movements in exchange rates are undesirable for economic growth. We continue to monitor exchange rates closely and cooperate as appropriate. Greater exchange rate flexibility is desirable in emerging economies with large current account surpluses, especially China, for necessary adjustments to occur.”

Analysts say this latest communiqué is significant in that it is a departure from typical verbiage.

“In the last several years of communiqués, there has been very little substance,” Buskas says. “They have tended to issue a pat statement on how currency valuations should reflect fundamentals.”

The G7 statement also outlined specific recommendations for several countries: in the U.S., further action to encourage and bolster the national savings rate; in Europe, structural reforms for labor markets, which in turn could spark domestic demand-led growth; in China, greater flexibility in exchange rates is critical and would help lessen its current export-led growth mode.

“The G7 focused not only on currency-rate adjustment, but on stimulating domestic demand in the countries with trade surpluses,” Dolan says. “Japan, China — most of the Asian economies are heavily export-led.”

If the Chinese authorities were to allow the yuan to strengthen against the dollar, the appetite for Chinese goods could slow, which could help ease the U.S. trade deficit.