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Wednesday May 21, 2008 - 20:56:50 GMT
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FOREX NEWS-Dollar falls broadly as Fed lowers growth forecast

 

Wed May 21, 2008 4:39pm EDT

(Recasts, updates prices, changes byline)

* Dollar drops to one-month low vs euro

* Fed lowers 2008 growth forecast

* German Ifo data fans speculation of ECB rate increase

By Lucia Mutikani

NEW YORK, May 21 (Reuters) - The dollar fell to a one-month low versus the euro on Wednesday after the Federal Reserve cut its 2008 growth forecast and warned of higher unemployment, reducing prospects of an interest rate hike later this year.

Although minutes of the Fed's April 29-30 policy meeting highlighted worries over inflation and signaled more interest rate cuts were unlikely, it was insufficient to halt the dollar's slide and it also touched a one-week low versus the yen.

"What people are responding to is that the Fed raised the bar on further interest rate cuts, but it also did not lower the bar for interest rate hikes. The markets were looking for some indication of the latter," said David Gilmore, partner at FX Analytics in Essex, Connecticut.

"The signal from there is that the Fed is not terribly confident about the economy coming out of this slowdown at any sort of pace that would warrant what the front end of the Treasury market is pricing, which is rate hikes by year-end."

The euro surged as high as $1.5791 <EUR=>, closing in on a record peak above $1.60 touched last month. It last traded at $1.5789, up 0.8 percent on the day.

The dollar dropped to a one-week low of 102.97 yen, before recovering to 103.01 yen, still down 0.6 percent. The dollar dived 1.1 percent to 1.0250 Swiss francs <CHF=>.

The New York Board of Trade's dollar index .DXY, which tracks the dollar's performance against a basket of six currencies, fell as low as 71.903.

FED SLASHED GROWTH FORECASTS

The slide in the dollar came as stocks tumbled on the combination of record oil prices and the Fed lowering its 2008 growth projections to a meager 0.3 percent to 1.2 percent from its estimate of 1.3 percent to 2 percent made three months ago.

The central bank also warned it expected unemployment to rise "significantly."

Some analysts said the minutes of the Federal Reserve's policy-setting Federal Open Market Committee suggested the U.S. central bank could still lower rates further this year.

"The FOMC minutes were expressing more concern about the downside risk than was generally anticipated in the market. Clearly the Fed is still very much in a data watch mode and would be ready to cut rates if need be," said Matthew Strauss, senior currency strategist at RBC Capital Markets in Toronto.

"That in itself caught a number of players off guard because they were looking for an indication that the Fed would clearly move to the sidelines in these minutes and that wasn't clear at all."

Short-term interest rate futures FFG8, which track market expectations for Fed policy, showed an 88 percent perceived chance that the central bank will keep benchmark lending rates unchanged at 2 percent after aggressively cutting them by 3.25 percentage points since mid-September.

Prospects for a rate hike by year-end were around 80 percent, from near 100 percent on Tuesday.

In stark contrast, a surprise improvement in German business sentiment bolstered the case for higher euro zone interest rates, adding to the bullish tone surrounding the euro.

The European Central Bank has held interest rates at 4 percent since last June, and expectations of slower euro zone economic growth in recent weeks had led investors to start pricing in a near-term rate cut.

But the recent string of strong data from Germany, the euro zone's largest economy, has called that outlook into question.

Meanwhile, against its Canadian counterpart, the dollar fell 0.9 percent to C$0.9832 <CAD=>, with the loonie boosted by high oil prices and a gain in April Canadian consumer prices. (Additional reporting by Steven C Johnson; Editing by Leslie Adler)

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