Dollar falls as U.S. rate outlook spurs bid for yield

NEW YORK Wed Apr 20, 2011 5:16pm EDT

NEW YORK (Reuters) - The dollar plummeted on Wednesday against major and emerging market currencies as the prospect that U.S. interest rates would remain at record lows encouraged investors to seek higher returns elsewhere.

The euro hit a 15-month high above $1.45, while rising commodity prices and inflation sent the Canadian and Australian dollars to multi-year peaks. Against major currencies, the greenback had its worst day in a month .DXY.

Perhaps more crucially, traders said, the dollar extended a multi-week slide against large emerging currencies, hitting two-year lows against the Brazilian real and Mexican peso.

China also allowed the yuan to touch a record high, and a top central bank official called for more currency flexibility to ease inflation.

Some analysts said this had markets betting that China would soon allow the yuan to rise even more quickly, which would likely put further pressure on the dollar.

"The only reason these countries would let their currencies strengthen is if they think their competitors for exports will also let their currencies go," said Douglas Borthwick, managing director of Faros Trading in Stamford, Connecticut.

Borthwick said a "one-off revaluation of the yuan is not out of the question" and that he expects that China's currency, up 1 percent against the dollar this year and 4.5 percent since mid-2010, could appreciate another 6 percent by year end.

EURO, AUSSIE SOAR

While China and others are tightening policy, markets expect the Federal Reserve to move slowly in soaking up all the dollars it has poured into the economy since 2008 to help the economy rebound from its worst recession since World War Two.

U.S. interest rate futures suggest the Fed won't raise its benchmark rate until the second quarter of 2012.

The European Central Bank hiked rates this month for the first time since 2008 and is expected to hike again. The contrast has helped boost the euro, which rose 1.2 percent on Wednesday to $1.4519, near an earlier 15-month high.

The chase for yields also boosted the Australian dollar to an almost three-decade high at $1.0693. The currency benefits from Australia's 4.75 percent interest rate and its role as a large supplier of raw materials and commodities for the booming Chinese economy.

The Canadian dollar rose to its highest in more than three years against the greenback, buoyed by Tuesday's above-forecast Canadian inflation.

The dollar also fell against the yen, down 0.3 percent to 82.36 yen.

GREECE RISKS LINGER

Some analysts, however, said euro strength may be nearing a peak, particularly if fears that Greece may have to restructure its debt become reality. A German government adviser on Tuesday said Greek restructuring was inevitable.

If it were to provoke similar steps in Portugal, Ireland and possibly Spain, the subsequent hit on European banks and the broader euro zone economy could drive the euro as low as $1.20, said Michael Hart, director of FX strategy at Roubini Global Economics in London

"Nothing is really different between now and when the Greek fears emerged last year and the euro was below $1.20," he said. "If anything, the situation is worse. Authorities tried to kick the can down the road but haven't even kicked it hard enough, because it's not 2013 we're talking about now but 2011."

But fears about U.S. finances may offset euro weakness.

S&P slapped a negative outlook on the United States' prized AAA credit rating this week for fear Washington would not act boldly enough to cut a $1.4 trillion budget deficit, and emerging central bank attempts to reduce reliance on the U.S. dollar could help support demand for other currencies.

"There's a desire to hold fewer dollars, and that's going to be supportive of the euro," said BNY Mellon strategist Michael Woolfolk.

(Additional reporting by Nick Olivari; editing by Leslie Adler)

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