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Tuesday June 3, 2008 - 20:18:53 GMT
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FOREX NEWS-Bernanke inflation risk comments ignite dollar rally

Tue Jun 3, 2008 4:10pm EDT

(Recasts, updates prices, changes byline)

* Dollar surges as Bernanke warns on weak currency impact

* Remarks suggest Fed unlikely to cut rates again

* U.S. factory orders unexpectedly rise in April

By Lucia Mutikani

NEW YORK, June 3 (Reuters) - The dollar surged on Tuesday after Federal Reserve Chairman Ben Bernanke warned the weak U.S. currency posed a risk to inflation, adding to views the central bank could raise interest rates later this year.

Bernanke's rare warning, made during an address to a conference on monetary policy in Barcelona, Spain, was seen by some market participants as the Fed's version of a "strong dollar policy," lending the embattled currency much needed support.

"The fact that these dollar supporting remarks have emerged from an institution with the means to control interest rates is somewhat unprecedented and bears the signs of the central bank's bid to support the U.S. currency," said Ashraf Laidi, chief FX strategist at CMC Markets in New York.

The euro <EUR=> dropped to $1.5411, its lowest level in nearly three weeks, surrendering overnight gains that had pushed it as high as $1.5628. In late New York trade, it was quoted around $1.5461, down 0.5 percent on the day.

The New York Board of Trade's dollar index, which charts the dollar's performance against a basket of six currencies, jumped to 73.501 .DXY, the highest since May 14.

"We saw the market turn around quite dramatically as soon as the comments hit the wire," said Stephen Malyon, senior currency strategist at Scotia Capital in Toronto.

"The market was struck primarily by the fact that a Fed governor would make comments specifically relating to the U.S. dollar, which is usually the purview of the U.S. Treasury Department. That underscores that the dollar is high on the minds of the Fed policy-makers."

Bernanke, speaking via satellite to the conference in Barcelona, said: "We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations."

The U.S. central bank and the Treasury, he added, were continuing to "carefully monitor" currency market developments.

Aggressive interest rate cuts by the Fed, aimed at warding off a recession, have undermined the dollar through a reduced yield appeal of dollar-denominated assets.

Short-term interest rate futures, which track market expectations for Fed policy, are pricing in a high probability of the central bank tightening monetary policy by year-end.

They showed a 98 percent perceived chance the Fed will leave its benchmark overnight lending rate at 2 percent this month after slashing it by 3.25 percentage points since mid-September.


Analysts said Bernanke's comments could be part of coordinated steps with other monetary authorities and it would not be surprising to see joint intervention in the foreign exchange market.

"The language used is a de facto red flag that currency intervention is on the table. I think intervention risk is very high and we could see it Wednesday and it would involve G7 central banks," said David Gilmore, partner at FX Analytics in Essex, Connecticut.

A report showing a surprise rise in U.S. factory orders for April also buoyed the dollar. For details, see [ID:nN02428961].

The dollar raced to a session peak of 105.56 yen <JPY=>, but gave up some gains as U.S. stocks fell and Lehman Brothers (LEH.N: Quote, Profile, Research) tumbled following a Wall Street Journal report the investment bank might need raise up to $4 billion in new capital.

Lehman later said IT did not access the Fed's discount window on Tuesday and said it "finished the second quarter well above $40 billion" in liquidity.

That saw the dollar extend gains versus yen to last trade at 105.14, up 0.6 percent on the day. (Editing by Leslie Adler)

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