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Wednesday June 4, 2008 - 10:59:04 GMT
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FOREX NEWS-Dollar holds gains after rare Bernanke warning

 
Wed Jun 4, 2008 6:49am EDT

(Changes byline, adds quotes, updates prices)

By Simon Falush

LONDON, June 4 (Reuters) - The dollar held steady versus a basket of six major currencies on Wednesday, keeping hefty gains made the previous session on Federal Reserve Chairman Ben Bernanke's warning about the inflationary threat from a weak U.S. currency.

The dollar index .DXY surged as much as 1.3 percent from Tuesday's lows after Bernanke said dollar weakness was adding to price pressures and that the Fed along with the U.S. Treasury were carefully monitoring currency markets [ID:nN03353007].

The comments suggested greater concern in Washington and the potential for dollar-buying intervention.

The dollar's tumble to record lows this year, driven by aggressive Fed rate cuts to limit damage from a global credit crunch, has caused a vicious circle by aggravating the effects of surging oil and commodity prices, which have helped to stoke inflation pressures.

The Fed rarely comments on the dollar, normally leaving currency policy to the U.S. Treasury, which made Bernanke's comments all the more surprising and heightened their impact across asset classes.

"It's signficant that Bernanke mentioned the explicit link between a weaker dollar and the inflation risk, and it has supported the dollar," said Lee Hardman, currency strategist at BTM-UFJ.

However he said the dollar's recent strength will likely be put to the test by data such as the ISM non-manufacturing PMI data at 1400 GMT and non-farm payrolls on Friday that will likely turn the spotlight back on the frailty of the U.S. economy.

"There are downside risks for the macro economic outlook and the ISM data and non-farm payrolls number have the potential to be a further catalyst for dollar weakness," Hardman said.

The euro was pressured by soft euro zone retail sales data which added to an impression that the European economy is also facing stiff headwinds.

By 1004 GMT the dollar index was largely steady on the day at 73.280 .DXY. The euro edged up to $1.5462 <EUR=>, but hovered near a three-week low of $1.5408 hit on Tuesday.

The single currency was little moved by data showing that euro zone service sector growth had slowed close to contraction [nL02514698], but briefly retreated after a surprising fall in retail sales [nL04582475].

The euro has now retreated more than 3 percent from record highs of $1.6018 hit in April, according to Reuters data.

The dollar fell a third of a percent against a broadly stronger yen to 104.74 yen <JPY=>, while the euro fell 0.25 percent to 161.90 <EURJPY=>.

Sterling continued to lose ground, hitting its lowest in two weeks after data showed the UK service sector posting its first shrinkage in five years and that sluggish consumer confidence had fallen further.

STRIKING A CHORD

Bernanke's comments have struck a chord as they mark a definitive move away from a long-running policy of "benign neglect" on the currency held by the U.S. Treasury.

The Fed chief's comments also suggested the central bank is unlikely to cut interest rates from 2 percent, and investors are looking for the next move to be a hike later in the year.

"We take this as a meaningful shift in rhetoric, currency strategists at Morgan Stanley said in a note to clients.

"The Fed would not have made these comments without the support of the Treasury, given that the Treasury has the responsibility for exchange rate policy. In that regard, we can view this as a coordinated signal from U.S. monetary authorities," they said.

Before the ISM data investors will closely monitor the ADP employment report at 1215 GMT for a possible early steer on U.S. non-farm payrolls figures due out on Friday.

The ADP report is expected to show 30,000 jobs were shed in May, according to economists polled by Reuters. (Reporting by Simon Falush; editing by Keith Weir)

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