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Wednesday March 21, 2007 - 21:17:16 GMT
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FOREX NEWS-Dollar hits 2-yr low vs euro as Fed softens bias

FOREX-Dollar hits 2-yr low vs euro as Fed softens bias
Wed Mar 21, 2007 3:56pm ET144

(Adds details of FOMC meeting, updates prices, adds comment, changes byline)

By Steven C. Johnson

NEW YORK, March 21 (Reuters) - The dollar tumbled to a two-year low against the euro on Wednesday after the Federal Reserve held interest rates steady but dropped a reference in its statement to possible further interest rate increases.

Though the Fed reiterated that inflation remains a concern, investors interpreted the language change as a sign that an interest rate cut may be near.

"It's altogether a bearish statement for the dollar. To begin with, the Fed changed the statement and that's the main highlight," said David Watt, senior currency strategist at RBC Capital Markets in Toronto.

"They just said future policy adjustments will depend on the evolution of inflation and growth, which may very well mean the next move is a rate cut," he said.

The euro shot up to $1.3390, its highest since March 2005, after the statement's release, before settling around $1.3385, up 0.5 percent since late on Tuesday.

The dollar also weakened against sterling and high-yield currencies such as the Australian dollar .

The euro got a particular jolt because markets expect more euro zone interest rate hikes this year from the current 3.75 percent.

That would cut into the dollar's yield advantage, giving the common currency an edge over the greenback. The Fed has held the benchmark fed funds rate steady at 5.25 percent since August.

Indeed, the dollar fared best against the low-yielding yen, paring gains to 117.55 yen after hitting a peak of 117.95 yen earlier. Japanese interest rates are just 0.5 percent.

U.S. interest rate futures, meanwhile, were pricing in a 48 percent chance of a rate cut by the end of June, up from 26 percent before the Fed's statement was released.


The Fed has repeatedly warned of inflation risks, and consumer prices have indeed shown little sign of moving back below 2 percent, the upper end of the U.S. central bank's comfort zone.

But financial markets have started fretting about the U.S. economy, particularly if defaults in subprime mortgages spread to other parts of the housing sector and cause growth to slow more quickly than expected.

Many investors have cut risky trades, boosting low-interest-rate curencies such as the yen and Swiss franc used to fund carry trades and roiling global equity markets. Recent U.S. data on manufacturing and output have also been on the soft side.

"The Fed has obviously reacted to the recent economic data, and the U.S. dollar has reacted poorly to this," said Firas Askari, head of FX trading at BMO Capital Markets in Toronto.

Alan Ruskin, chief international strategist at RBS Greenwich Capital, said the Fed still hasn't signaled that slower growth is as big a risk as rising inflation.

But he said the central bank "has taken one solid step away from a clear bias to tighten."

"The Fed's statement appears both less confident of the outlook and less optimistic," said Marc Chandler, senior currency strategist at Brown Brothers Harriman in New York.

He said the euro should face near-term resistance around $1.3380, but a break of that would put $1.3420 in range.

(Additional reporting by Vivianne Rodrigues and Gertrude Chavez-Dreyfuss)

© Reuters 2007. All Rights Reserved.


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