EUROPE'S MONETARY STRAINS LIKELY TO HURT US DOLLAR, ANALYSTS SAY

EUROPE'S MONETARY STRAINS LIKELY TO HURT US DOLLAR, ANALYSTS SAY

Strains in the European Monetary System don't bode well for the U.S. dollar, currency traders and analysts said.

They differed on where the splits would appear first - Spain, Italy, or Greece - but agreed that there will be a run on the high-yielding currencies in southern Europe that will make the mighty deutsche mark even mightier. Of course, that will put pressure on the dollar.The failure of the powerful Bundesbank to cut its interest rates before going on summer vacation threw cold water on any ideas that the Group of 7 has some grand plan to rescue the dollar.

Meanwhile, Bonn is not fighting the prestigious rise in the German currency, despite some complaining from exporters. The strong deutsche mark is good for you, the government told Germans on Friday.

Anxious to highlight the positive side of a rock-solid currency that businesses say threatens exports, profits and jobs, the finance ministry said vacationers, at least, were benefiting from longer or cheaper foreign holidays.

"The mark is strong - German holiday-makers can be pleased," it said in a statement. "The deutsche mark is one of the strongest and most stable currencies in the world."

The Bundesbank itself is on holiday until the middle of August, and analysts said it is unlikely to cut rates before then, barring some kind of emergency.

If the dollar keeps slipping against the deutsche mark, analysts said, this will shake peoples' confidence in the stability of the dollar against other currencies as well as the mark.

"I don't like the dollar because the negative fundamentals are still there," said Bob Lynch, currency analyst at MMS International. "There may be some short-term bounces in the dollar, but long-term you have to be bearish."

Other analysts agreed that the United States needs to make substantial progress on the trade and budget deficits, and many market participants are worried about "crunch time" later this year.

"The talk is that the White House and the Congress are headed for a collision when the Treasury asks for an increase in the U.S. debt limit," said Earl Johnson, international economist and currency analyst at Bank of Montreal in Chicago.

"It will be close to year-end before we see any improvement in the budget deficit numbers," Mr. Johnson said. "And because imports into the United States remain so strong, we might not see improvement in the trade deficit for some time."

Mr. Johnson said it was encouraging to see the dollar bounce back late last week, "but the sell-off in stocks and bonds on Wednesday hurt the

dollar's technicals and did some lasting damage."

He said stability in U.S. asset markets is a pre-condition for a dollar rally, but will not in itself help the dollar much.

An important "read" on the economy will come Friday when the U.S. second quarter gross domestic product data are released. The consensus forecast is for meager 0.4 percent growth.

The slowdown would come as no surprise, but the GDP deflator's improvement has the potential to affect U.S. monetary policy.

"The GDP deflator, a closely watched measure of inflation, could be as low as 1.9 percent" in the second-quarter report, Mr. Lynch said. "Receding inflationary pressures could be seen as a reason the Federal Reserve will cut interest rates again before too long."

June existing home sales and July consumer confidence are on tap Tuesday. The pace of home sales is forecast up 2.8 percent at 3.65 million units. Consumer confidence is expected to rise to 94.0 percent from June's 92.8 percent.

Analysts at Salomon Brothers in Tokyo said the dollar's recent strength in the wake of coordinated intervention by the Federal Reserve and the Bank of Japan should prove short-lived, "as it is not supported by credible monetary policy moves."

"In the near term," they said, "the yen should rebound toward a trading range centered on 83.00 yen to the dollar, as investors refocus on the snail- paced reduction of Japan's large current account surplus and limited private capital outflows."