How holiday shopping may affect the dollar

updated 1:59 p.m. ET Dec. 6, 2006

NEW YORK - While you're out battling the crowds at the mall or shopping for hot toys this holiday season, what you're buying and how much of it could influence the dollar's future moves.

In addition to dictating the level of retailers' profits, sales volumes this Christmas could signal whether consumers once again are riding to the rescue of an economy that is showing signs of slowing dramatically. And that may have great sway over what the Federal Reserve decides to do with interest rates in the months ahead.

That matters for the dollar since its recent plunge largely has been sparked by fears that investors will cash out of dollar-denominated assets as U.S. rates decline and instead put their money into areas of the world where rates are rising.

For most of this year, the dollar's slide has been overshadowed by bigger financial-market news: The rally that boosted major stock indexes to levels not seen since the dot-com boom and the retreat in oil prices from the highs seen over the summer.

In recent weeks, however, the slumping dollar has become harder to ignore. The greenback has plunged to its lowest level in 20 months against the euro and is at 14-year lows against the British pound. So far this year, the dollar has lost nearly 7 percent of its value against an index of major foreign currencies, according to the Federal Reserve.

The Bush administration has shown no signs that it plans to do anything to stem its decline. The weak dollar helps to lower the huge U.S. trade deficit by making American goods cheaper and more competitive abroad and foreign goods more expensive here. But it also could boost inflation if the price of foreign-made goods rise in this country, something the Fed doesn't like to see.

A combination of factors are being blamed for the dollar's pullback. For one, there has been speculation that China may shift part of its $1 trillion foreign-currency reserves — the biggest in the world — away from the dollar and into other major currencies.

Improving business conditions in Europe, namely in Germany, are also helping drive up currencies there, as investors look to put money into markets where profit growth is picking up as opposed to the United States where it is expected to start slowing down.

But most importantly, investors see interest rates abroad rising. The European Central Bank has bumped up its key interest rate five times to 3.25 percent in the last year, and more increases are expected.

That counters the monetary policy currently embraced by the U.S. Fed, which has held short-term rates steady at 5.25 percent since August after raising rates 17 times in quarter-point increments over the last two years.

While the U.S. interest rates still yield more than those in Europe, the big question is how long that gap will last.

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