Paulson's dollar policy tweak may only slow slide

U.S. officials have thrown a rhetorical lifeline to the downtrodden dollar by expressing faith in the economy's long-term fundamental prospects.

But the effort may only brake the greenback's slide as long as financial markets expect U.S. interest rates to move lower.

Treasury Secretary Henry Paulson's tweaking of Washington's strong-dollar mantra to stress the U.S. economy's fundamental strength appears to be an effort to talk the dollar up, or at least ensure a decline that has taken it to a record low against a basket of major currencies does not become a rout.

A strong dollar is very much in our nation's interest, he said on Thursday, reiterating a long-standing currency mantra ahead of a weekend meeting of finance ministers from the Group of 20 industrialized and emerging market economic powers.

But, in a new flourish to this well-honed phrase, Paulson added: Our economy, like any other, goes through ups and downs but I believe the U.S. economy is going to continue to grow and its fundamental long-term strength is going to be reflected in currency markets.

Paulson repeated the fresh-hewn rhetoric on Friday, making clear it was a purposeful shift, although one that does not move the Bush administration away from its belief that currency values should be set in open, competitive markets.

You heard the point 'being reflected in currency markets', right?, he said to a reporter to drive the point home.

NOT INDIFFERENT TO DOLLAR

The new language amounts to an effort to build confidence in the embattled greenback's value -- an effort President George W. Bush also joined last week -- and assure allies and warn traders that Washington is not indifferent to the dollar's fate.

By the modest shift in rhetoric, the administration hopes to counter market and official concern that the U.S. is indifferent to a weak dollar or, more, favors a weaker dollar, currency strategist David Gilmore of Foreign Exchange Analytics in New York, said.

In other words there is no hidden 'beggar thy neighbor' weak-dollar policy hiding behind the mantra, he added.

A similar point was made by Morgan Stanley research analyst Sophia Drossos.

She wrote that Paulson's remarks appear aimed at offering additional context on the strong-dollar policy to make it more credible in the current environment and disavowing the view that the Treasury maintains a 'benign neglect' policy toward the dollar.

The rhetorical shift appears aimed, at least in part, at easing rising anxiety in Europe and Canada that their soaring currencies would undercut their economies by making their exports relatively more expensive in global markets.

But the dollar's value will likely face more strains in the short run as a sagging housing sector, softer consumer spending and slower manufacturing activity weigh on the U.S. economy.

The Federal Reserve has already cut benchmark U.S. interest rates by three-quarters of a percentage point over the last two months and financial markets expect rates to fall further, even though Fed officials have signaled a rate-cutting reluctance.

The shift in dollar rhetoric emerged just more than a week ago.

I have no doubt that looking out over any reasonable period of time, you're going to see our strong economic fundamentals in this country shine through, Paulson said when asked about the dollar's drop at a news briefing on November 9.

Bush joined the campaign on Tuesday. If people would look at the strength of our economy, they'd realize why ... I believe the dollar will be stronger, he said in a television interview.

Fed Chairman Ben Bernanke, who usually defers comment on the dollar's value to the Treasury, has also weighed in.

He told lawmakers on November 8 that the currency's strength would ultimately depend on the state of the U.S. economy, global trade, and openness of U.S. financial markets.

I'm optimistic on those fronts, and I do believe that will lead to a sound dollar in the medium term, Bernanke said.

(Editing by Nick Edwards)