Agence France-Presse | October 22, 2007

The head of the International Monetary Fund, Rodrigo Rato, warned Monday there are risks of an "abrupt fall" in the dollar, linked to a loss of confidence in dollar assets. 
"There are risks that an abrupt fall in the dollar could either be triggered by, or itself trigger, a loss of confidence in dollar assets," Rato told the IMF board of governors.

He also appeared to suggest that Europe could take steps to temper the strong appreciation of the euro.

"There is a risk that exchange rate appreciation in countries with flexible exchange rates -- including the euro area -- could hurt their growth prospects, and that in these circumstances protectionist pressures could worsen," he said on the final day of the annual meetings of the IMF and the World Bank.

The outgoing IMF managing director spoke as the European single currency hit a new high of 1.4347 dollars and global equity markets tumbled amid growing fears a US housing-related credit crunch could pitch the world's biggest economy into recession.

"The uncertainty ... comes from downside risks that are much higher than they were six months ago. The turbulence in the credit markets is a warning that we cannot take the benign economic environment of recent years for granted," he said.

"We still do not know the full effects of the decline in the housing market and the subprime problems of the US economy. Further disruption in financial markets and further falls in housing prices could lead to a global economic downturn."

A crisis in the risky US subprime mortgage sector, where loans are given to homebuyers with poor credit histories, erupted this year as borrowers defaulted on mortgages amid rising interest rates and a sharp slump in US housing prices.

The spillover of the US credit crunch into global financial markets roiled stock markets worldwide in August and although they have recovered somewhat, the uncertainties of the extent of the credit problems continues to weigh on investors.

Rato warned that a downturn would exacerbate other risks that already exist in the world economy, citing some emerging economies' reliance on capital inflows and the potential that central banks may not curb rising inflationary pressures.

"Some emerging economies that have relied on external financing to fund large current account deficits could be tipped into crisis by a combination of reduced demand for their exports and tighter financial market conditions," he said, adding that those developments would also worsen the prospects of low-income countries.

"And there is a risk that central banks may falter in fighting the inflation which has been spurred in some countries by higher oil and food prices."

Rato told the governors of the 185-nation financial institution aimed at fostering global financial stability that it was imperative to take action to avoid such a calamitous downturn from global imbalances.

"All of these risks make action on already agreed policies more urgent," he said.

"Major economies need ... to take supporting policy actions," said the former Spanish finance minister, who is stepping down nearly two years before the end of his five-year mandate.

His successor, Dominique Strauss-Kahn, a former Socialist finance minister of France, takes office on November 1.

In an apparent reference to recent pressures from France and other members of the 13-nation eurozone on the European Central Bank to take action to curb the euro's sharp appreciation, which is weighing on eurozone exports, Rato said: "Policymakers need to respect the independence of central banks and support their vigilance on inflation."