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Wednesday December 17, 2008 - 23:01:19 GMT
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FOREX NEWS-Dollar hits 13-1/2 year low vs yen, plunges vs euro

Wed Dec 17, 2008 4:09pm EST

* Dollar hits 2-1/2 month low vs euro a day after Fed move

* Dollar plunges to 13-1/2 year trough vs yen below 88

* Fed's historic rate cut seen keeping dollar weak

* BoJ seen cutting rates later this week

(Adds comments, updates prices, changes byline)

By Vivianne Rodrigues

NEW YORK, Dec 17 (Reuters) - The U.S. dollar tumbled against major currencies on Wednesday, hitting its weakest level in more than 13 years versus the yen, a day after the Federal Reserve cut interest rates to virtually zero.

The euro rallied to its strongest level against the greenback this quarter after the U.S. central bank's massive rate cut further widened the interest rate differential in favor of the single euro zone currency.

"The Federal Reserve is prepared to flood the system with liquidity. We've pretty much gone to a zero interest rate structure," said Tom Fitzpatrick, global head of FX strategy at Citigroup Inc. in New York. "Neither of those are very supportive of the dollar."

In a sign of the huge volatility that has roiled the currency market since summer, the dollar abruptly reversed its upward trend of the past four months.

Its current trajectory puts the dollar index, which measures the greenback against a basket of six currencies, on pace for its biggest weekly loss in about 35 years, according to Reuters data. It is down about 5.5 percent on the week.

Fears have risen that the Fed's rate cut further diminished the yield appeal of the U.S. currency, making dollar assets less attractive. The greenback also came under pressure on worries the increase in the supply of money in the financial system would erode the dollar's value, analysts said.

In late afternoon trading in New York, the euro rose to a new two-and-a-half month high at $1.4436, according to Reuters data. It was last up 2 percent at $1.4383 <EUR=>, and has rallied about 13 percent so far this month.

"The Fed has been progressively more aggressive in attacking the dollar," said Axel Merk, manager of the Merk Hard Currency Fund in Palo Alto, California. "Low interest rates are the traditional policy tool to make a currency less attractive."

The Fed on Tuesday cut its federal funds rate target to a record low, setting a range of zero to 0.25 percent compared with the previous level of 1.0 percent. That contrasted with the more cautious approach of the European Central Bank, which recently hinted that it may not cut again in January.

"The fact that the Fed made this major policy move yesterday really changed the balance of power towards the euro for the time being," said Boris Schlossberg, director of currency research at GFT Forex in New York. "The underlying story in the FX market remains yield."

EYES ON BOJ

Against the yen, the dollar fell to 87.15 yen <JPY=>, the lowest since mid-1995. It was last down 1.7 percent at 87.38.

The move stoked speculation that Japanese authorities may intervene to rein in the yen's strength. Japan's top financial diplomat said on Wednesday that rapid movements in currency markets are undesirable [ID:nTKU003256].

The Japanese currency has rocketed in recent months as investors unwound carry trades, cutting exposure to riskier and higher-yielding assets as the financial crisis mushroomed. The dollar has lost nearly 9 percent against the yen this month and 18 percent this quarter.

The yen's rally picked up momentum after the Fed's move brought U.S. interest rates below the Bank of Japan's target for the overnight call rate -- now at 0.30 percent -- for the first time in well over a decade.

The BoJ starts its two-day monetary policy meeting on Thursday. Two-thirds of analysts polled by Reuters now expect the BoJ to cut rates this week, and most of them see rates falling to 0.1 percent. See [ID:nT238594].

(Additional reporting by Wanfeng Zhou in New York; Editing by Chizu Nomiyama)

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