Crown jewels: Best-performing pairs vs. the U.S. dollar

The British pound and the Australian dollar should be the best-performing currencies against the U.S. dollar as the Federal Reserve cuts interest rates. Even without any liquidity injection by the Bank of England (BOE), the UK economy has been holding up extremely well, with both its housing market and domestic demand remaining relatively steady.

As of late August, the market was still looking for one interest-rate hike from the BOE by the end of the year, taking the rate up to 6 percent. The BOE has long been one of the most effective central banks in the world because of its lack of commitment to a multi-year monetary policy cycle; it is willing to respond quickly to economic fluctuations. Also, the UK’s business friendly policies have made its companies and financial markets the preferred destination for cross-market mergers and acquisitions, which in previous years has helped prop up the British pound even when growth was beginning to slow.

The Australian dollar should outperform the U.S. dollar for several reasons. First, the Aussie economy remains relatively strong. The unemployment rate is holding near a 33 year low, which has fueled strong household consumption and healthy business activity.

Second, the recent Aussie dollar sell-off should benefit Australian exports. Between July 25, 2007 and Aug. 17, 2007, the Australian dollar fell nearly 1,200 pips, or 13.5 percent. As an export-dependent economy, the currency’s sharp fall should help boost global demand for Australian exports. China, which has been relatively insulated from the liquidity squeeze and credit crisis, has been a big buyer of Australian commodities over the past few years. This demand should only grow given the recent fall in the Australian dollar.