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Wednesday August 9, 2006 - 11:06:50 GMT
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FOREX-Dollar weakens as investors digest Fed decision

FOREX-Dollar weakens as investors digest Fed decision
Wed Aug 9, 2006 6:41am ET162

(Updates price, adds quotes, byline)

By Toni Vorobyova

LONDON, Aug 9 (Reuters) - The dollar eased against the euro and the yen on Wednesday, staying above recent troughs after the Federal Reserve halted its 2-year old tightening campaign but left the door open for more rate hikes later.

The yen slid to record lows against the euro and eight-year troughs against sterling, as rate hikes last week from the European Central Bank and the Bank of England underscored the Japanese currency's low yields.

The Fed bucked the rate-hiking trend on Tuesday, leaving rates at 5.25 percent, adding that its previous spree of rate rises should help moderate inflation over time even though risks of a pick-up in price pressures remained.

Investors interpreted the comments as leaving the door open to more rate hikes after a pause in the Fed's two-year tightening campaign, triggering a wave of short covering.

But on Wednesday the dollar erased any post-Fed gains, as investors refocused on the pause in tightening.

"It's a continued reaction to the Fed pausing last night ... After that we saw the dollar marginally outperforming with people taking off dollar shorts," said Geoff Kendrick, currency strategist at Westpac.

"Now that's passed, people today are realising that the Fed has paused and is probably now on hold for a while so at the margin it should be a little bit dollar negative."

By 1025 GMT, the euro was up 0.3 percent at $1.2873 , still some way off last week's two-month peak of $1.2909. The dollar was also a bit softer at 115.13 yen .

The dollar stood at 84.61 <=USD> against a basket of major currencies having hit a two-month low of 84.39 last week.


The euro rose as high as 148.34 , its highest since the single currency was launched in 1999. The yen hit an eight-year low against sterling for the fifth day in a row, at 220.13 yen .

The Bank of Japan is seen holding rates at 0.25 percent on Friday after raising them for the first time in six years last month. Even another rate hike by year-end would leave Japanese yields far below those of other major economies, meaning the yen remains an attractive funding currency.

"The yen remains the worst performing G10 currency in the last week and month against the dollar and euro, perhaps as the search for yield leaves the yen looking very unattractive," Royal Bank of Canada said in a note to clients.

Nonetheless the yen trimmed some losses after Japanese machinery orders leapt, underscoring how capital spending is helping to drive Japan's economic expansion.

Orders jumped 8.5 percent in June from a month earlier, The median forecast in a Reuters poll was for a fall of 0.4 percent.


In the United States, economists are divided over whether the Fed was now done raising rates, according to a Reuters poll.

Thirteen of 23 primary bond dealers with the Fed believe this wraps up the credit tightening campaign. Only four expect a rate increase at the central bank's next meeting in September.

An anticipated Fed pause has hurt the dollar this year, especially as the ECB and others have steadily ratcheted rates higher.

The Bank of England, in its quarterly inflation report, signalled that interest rates will probably need to rise a little further in order to keep inflation on course.

But sterling weakened against the dollar and the euro after the report and comments from BoE Governor Mervyn King were not seen as upbeat enough to point to another rate hike in the near term.

Elsewhere, high-yielding Australian and New Zealand dollars firmed against the U.S. currency, with the kiwi hitting a two-month high .

"It's a bit of a return of risk appetite, I guess, with the Fed not hiking last night," Kendrick said.

"We have important Aussie and Kiwi employment data today and I think they will probably show that both economies remain in reasonably good shape."

© Reuters 2006. All Rights Reserved


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