Global deflation threats seen hidden in ECB's bond-buying effort

[LONDON] Mario Draghi's inflation bomb could prove to be a dud.

That's because the weakness in the euro resulting from the European Central Bank's 1.1 trillion euro (S$1.64 trillion) quantitative-easing program risks being more than offset globally by the deflationary impact of a stronger dollar.

Making that case as the euro trades around its lowest in 11 years against the greenback is David Woo, head of global rates and currencies at Bank of America Merrill Lynch in New York. He's telling clients that pressure from a rising dollar threatens to rattle emerging markets, undermine US stocks and curb commodities prices.

Here's how: First, the higher the dollar goes the more likely investors will flee developing nations; that will make their borrowings in the US currency more expensive, damaging their already-shaky outlook for growth.

As Mr Woo notes, the Turkish lira and Mexican peso have both reached or traded near all-time lows against the dollar in the past few days and Brazil's real is at its weakest since 2004.

China, which manages the value of its yuan against a basket of other currencies, may be forced to devalue to keep its products cheap in the international marketplace.

Next, because commodities are priced in dollars, the higher the greenback goes the more downward pressure will be applied to oil prices. Bank of America already says the likelihood is greater that crude falls rather than rises.

Finally, Mr Woo estimates the dollar's rise is starting to undermine profits at home. US companies in the Standard & Poor's 500 Index get 40 per cent of their earnings from overseas and the index has fallen in 19 out of 27 trading days this year in which the greenback gained.

"The obvious implication is that investors are becoming concerned about the ability of the US economy to cope with the strengthening dollar," Mr Woo said in a report to clients on Monday. "The decline of euro/dollar below 1.10 may be less benign than it may appear at first."

BLOOMBERG