---- by Christopher Anstey ----
WASHINGTON (AFX) - Capital inflows into the US are expected to moderate after sharp declines in US equities and rising prospects for a recession, which will lead the dollar to depreciate moderately in the medium term, analysts said.
"We do see a slowing in the import of capital," said Robert Hormats, Vice Chairman of Goldman Sachs International. Goldman Sachs economists believe the dollar will weaken against the euro as a result of Europe being likely to outperform the US, with fewer negative earnings surprises, Hormats said.
However, US-based analysts said there is no evidence of a large-scale retreat by European investors, and the extent of dollar depreciation expected now remains broadly the same as that projected before the Sept 11 terrorist attacks on the US.
"You are seeing a slowing in capital inflow," said Lisa Finstrom, currency analyst at Salomon Smith Barney, "but it's not reversing." Hormats explained that there need not be a reversal in capital flows from Europe to the US in order to affect the dollar, but only a slowing in the rate of inflow.
The US needs increasing inflows of foreign capital in order to finance its rising current account deficit, analysts said. With slowing capital inflows, "the overall monthly current account deficit does leave us vulnerable to potential exchange rate pressure," Finstrom said.
Hormats cautioned that "it's not as if European economies are that much better off," and concluded that "I don't think you'll see a wholesale pullback" from US assets.
Michael Rosenberg, head of foreign exchange research at Deutsche Bank Securities, noted that the dollar has only fallen 1.5 pct on a trade-weighted basis since the Sept 11 attacks, which badly damaged US confidence levels.
"We do look for the euro to do better" over the medium term, Rosenberg said, because of the euro's undervaluation against the dollar -- which pre-dates Sept 11.
Finstrom agreed that "the dollar was pushed into overvalued territory" before Sept 11.
"Exchange rates overshoot, and then come back towards fair value," Rosenberg said, which for the euro would be "near parity" against the dollar.
"There were forces that were moving us there before Sept 11," Rosenberg explained, and the exacerbation of the US slowdown caused by the terrorist attacks will simply reinforce that movement. Analysts said there are still a number of reasons for European investors to continue putting funds into the US, albeit at a slower pace than before.
"People still have a good bit of confidence in the US to weather the crisis," Finstrom said, noting that US policymakers have already used fiscal and monetary policy to counter the impact of the attacks. In fixed-income markets, meanwhile, there is an incentive for European investors to take advantage of widening spreads between corporate and Treasury securities, Rosenberg added.