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Wednesday May 27, 2009 - 20:54:20 GMT
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FOREX NEWS-Dollar gains vs euro as credit anxiety eases

Wed May 27, 2009 4:15pm EDT

* Dollar gains on euro as credit rating fears ease

* Sterling hits $1.60 for first time since November

* Five-year Treasury auction attracts strong demand

* Euro struggles after ECB official comment on rates (Adds detail, comment)

By Steven C. Johnson

NEW YORK, May 27 (Reuters) - The dollar rose against the euro on Wednesday as fears of a U.S. credit downgrade faded and a European Central Bank official said interest rates could fall further if economic conditions worsen.

The British pound, however, soared above $1.60 for the first time in nearly seven months, propelled by hopes of improvement in the UK economy and banking sector.

The dollar fell last week as concern that a multitrillion-dollar U.S. deficit was putting the United States' AAA credit rating at risk lifted the euro above $1.40 to its highest since early January.

But fear that foreigners would lose their appetite for U.S. assets faded after an auction of $35 billion in new five-year Treasury notes drew solid demand. Investors also turned out in large numbers for $40 billion of new two-year debt on Tuesday.

Recent euro gains "were driven not by any organic demand for euro but by fear of a possible U.S. downgrade," said Boris Schlossberg, director of FX research at GFT Forex. "That's why $1.40 has been such a cement ceiling for the euro -- the fear trade has run out of gas."

The euro was last down 0.7 percent at $1.3885 <EUR=>, having failed to break above $1.40 earlier in the global session. The dollar was up 0.2 percent at 95.19 yen <JPY=> while sterling was up 0.5 percent at $1.6006 <GBP=> after hitting $1.6085, its highest since November.

Sweden's crown <SEK=> fell sharply after the country's central bank said it would boost foreign currency reserves by $13.3 billion to finance loans to Swedish banks. [ID:nLR280170]

EURO WOBBLES, DOLLAR STILL VULNERABLE

The euro has climbed more than 5 percent against the dollar so far in May, lifted partly as cautious optimism about the world economy dulled the U.S. dollar's safe-haven appeal.

That view was shaken a bit this week, analysts said. European Central Bank governing council member Erkki Liikannen stoked some doubt when he said the bank's current key interest rate of 1 percent could go lower. [ID:nLR89759]

Also, U.S. housing data on Wednesday showed the inventory of unsold homes rose last month, stoking worries that prices have further to fall. That cooled some of the optimism seen on Tuesday after data showed a jump in U.S. consumer confidence.

Currencies of high interest-rate countries such as Australia <AUD=> and New Zealand <NZD=>, which tend to fall with risk appetite, shed more than 1 percent against the dollar.

"Things are still not that great out there," said Robert Blake, a senior currency strategist at State Street Global Markets in Boston. "It's going to be a long, slow recovery and we will have more bad news to come."

Despite the well-received U.S. auction, longer-dated Treasuries fell and the spread between two- and 10-year yields widened to 2.75 percent, beating a previous peak set in 2003.

Investors said rising yields were adding to fear that the U.S. government could face a higher cost of borrowing at a time when it needs to finance a growing deficit.

"The two-year auction was great, the five-year was OK, but we won't know if things are OK or not until we get the 10-year, as the further you go out in duration, the more critical it is that the U.S. can get funding," said Steven Butler, head of currency trading at Scotia Capital in Toronto.

Treasury will auction 10-year notes in June.

Currency strategists at Citigroup said dollar selling was likely to resume, with the euro eventually testing the $1.4720 area last seen in December. (Additional reporting by Vivianne Rodrigues; Editing by James Dalgleish)

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