Dollar's slide: It's the economy, stupid

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NEW YORK (CNNMoney.com) -- The Federal Reserve's decision to cut interest rates by a half-percentage point Wednesday sent the dollar lower against the euro and the yen, but the Fed is not the only problem for an already battered dollar.

Currency experts argue that the fate of the seemingly soft U.S. economy will now largely dictate the direction of the greenback.

"The underlying economic data is getting more attention," said Robert Sinche, chief currency strategist at Bank of America.

Much of the dollar's decline in recent months can be blamed on the Fed's recent policy actions, as rate cuts make dollar-denominated investments less attractive to outside investors.

In October, the central bank cut the key federal funds rate, which affects the rate at which consumers borrow on a variety of loans, by a quarter of a percentage point, following a half-point cut in September.

Last week the Fed took an even more aggressive stance on the economy by implementing an emergency interest rate cut of three quarters of a percentage point, followed by Wednesday's half-point cut.

The central bank's efforts may stimulate economic growth. But U.S. recession chatter has been growing as housing market problems persist, consumer confidence wanes and signs increase that job growth is slowing. Those fears worsened Wednesday after an early fourth-quarter reading on GDP revealed weaker-than-expected growth.

But experts like Meg Browne, senior currency strategist at Brown Brothers Harriman in New York, among others, argues that if U.S. economic data remains soft as expected going forward, the dollar will remain under pressure, building on last year's losses against other major currencies including the euro, British pound, Canadian dollar and Japanese yen.

In 2007, the U.S. Dollar Index, which measures the currency's performance against six of its biggest trading partners, finished over 8% lower.

Stephen Malyon, a currency strategist at Scotia Capital in Toronto, anticipates that the dollar's weakness will persist at least through the first two quarters of this year. He anticipates, for example, that the euro will climb to $1.55 against the dollar by the end of the second quarter, above the record trading high hit in late November.

Part of that bearish sentiment for the dollar is rooted in insistence by foreign central banks, including the European Central Bank, or ECB, to leave interest rates at more elevated levels, attracting investors who favored the dollar in years past.

"Right now a hawkish ECB and a panicky looking Fed plays positively for the euro," said Malyon.

Experts, however, argue that the dollar should hold its current levels against the yen and ease only slightly against its Canadian counterpart in the coming months.

Luckily for consumers - who see their buying power overseas dwindle as the dollar's value evaporates - the long-term outlook for the greenback looks a bit better.

Currency experts like Malyon and Browne argue that the dollar will rebound modestly during the latter half of 2008. But even then, their outlook is tempered by one thing: the health of the economy.