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Tuesday June 17, 2008 - 11:49:32 GMT
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Forex News - Dlr slips, stg slides as rate expectations swirl

Tue Jun 17, 2008 7:43am EDT

* Dollar on back foot as Fed rate hike bets questioned

* Euro gains capped by Bini Smaghi comments, ZEW

* BoE's King strikes dovish tone despite UK CPI spike

* U.S. PPI, current account, housing data up next

(Changes byline, updates prices, adds quotes)

By Jamie McGeever

LONDON, June 17 (Reuters) - The dollar slipped against the euro while sterling sold off widely on Tuesday as traders broadly scaled back expectations of how high U.S., euro zone and UK interest rates will be raised to tame inflation.

The dollar initially weakened broadly after the Financial Times and Wall Street Journal reported Fed officials suggesting market expectations of how high and quickly U.S. rates will be raised had gone too far.

There was also a scaling back of rate hike bets in the euro zone after European Central Bank Executive Board member Lorenzo Bini Smaghi said that a quarter-point rate hike should be enough to bring inflation below the ECB's 2 percent target.

Then Bank of England Governor Mervyn King, in a mandatory letter to the UK Treasury explaining why inflation surged more than a percentage point above the BoE's 2 percent target, said the path for interest rates remained "uncertain".

"From a macroeconomic persepctive there is still uncertainty about the outlook in the U.S. and there is some feeling that the market has got ahead of itself," in expecting rate hikes, said Phyllis Papadavid, currency strategist at Societe Generale.

"And the BoE is in an uncomfortable situation. Growth isn't looking particularly good ... but they have to grapple with these higher inflation rates. It certainly isn't a good time for sterling," she said.

At 1115 GMT the dollar index was down 0.1 percent on the day at 73.63, .DXY.

The euro was up 0.2 percent against the dollar at $1.5500 <EUR=>, a cent off its intraday peak.

Sterling was down 0.7 percent against the dollar at $1.9500 <GBP=> -- almost 2 full cents down from its intraday high -- and the euro was up 0.8 percent against sterling at 79.50 pence <EURGBP=>.


U.S. interest rate futures markets are currently pricing in around 75 basis points of policy tightening from the Fed this year, effectively three hikes of 25 basis points each. Late last week, these markets had priced in almost 100 basis points of hikes. For more on the WSJ and FT stories, see [ID:nL17668926].

The dollar resumed its broad move lower on Monday after a weekend Group of Eight meeting yielded no joint statement about the weakness of the U.S. currency and data showed manufacturing in New York state contracting in June for the fourth time in five months.

"We certainly don't see the Fed putting on 50-75 basis points this year so our view is that markets were getting ahead of themselves," said Martin McMahon, FX strategist at Credit Suisse in Zurich.

U.S. producer prices and housing starts data for May and first quarter current account figures could offer more clues to the Fed's rates path at 1230 GMT.

Quarterly earnings results from Goldman Sachs (GS.N: Quote, Profile, Research, Stock Buzz) are also due later on Tuesday, potentially a reminder to investors that the credit crisis isn't over.

In Europe, meanwhile, the main mover for FX markets on Tuesday was the UK consumer price index for May. The annual rate jumped to 3.3 percent from 3 percent, the highest since the BoE was granted independence in 1997 and more than enough to prompt a letter to the Treasury from King explaining the rise.

But King struck a rather more 'dovish' tone than many had expected, arguing that aggressive action to cool price pressures over a 12-month horizon would spur market volatility and that inflation could even undershoot its target over two years.

"For the time being we expect the Bank of England to sit on its hands. We still see the next interest rate move being downwards, albeit likely delayed relative to our previous view," said George Buckley, UK economist at Deutsche Bank.

In the euro zone, Germany's ZEW index of economic sentiment for June came in sharply below forecasts (See [ID:nL1790411]), pushing down euro zone yields and implied rates.

The euro was little changed on the day against the yen at 167.42 yen <EURJPY=>, slipping off an earlier 11-month peak of 167.82 yen.

The dollar was steady against the yen at 108.10 yen, still off the four-month highs set on Monday <JPY=>.

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