Dollar drops after weak data; euro still vulnerable

A man is reflected on an electronic board displaying exchange rates in a business district in Tokyo May 16, 2011.

NEW YORK (Reuters) - The dollar slid on Thursday as weak U.S. economic data affirmed expectations the Federal Reserve will keep monetary policy ultra-loose for a while, keeping interest rates for the greenback very low compared with higher yielding currencies.

The Fed is widely expected to refrain from raising rates this year, and if economic data continues to disappoint it could push out Fed action until well into 2012 or perhaps even later.

"The Fed cannot raise rates in a slowing economic environment," said Douglas Borthwick, managing director at Faros Trading in Stamford, Connecticut.

"Given the U.S. Treasury states currencies should reflect economic fundamentals, we see a weaker (dollar) going forward."

Data showing a slowdown in manufacturing growth in the U.S. Mid-Atlantic region and an unexpected dip in existing home sales in April triggered dollar selling and added to growing signs that U.S. economic prospects were far from upbeat.

Some global central banks have already embarked on a path of monetary tightening, making their assets more appealing and lifting their currencies. The European Central Bank last month raised rates for the first time since July 2008.

Interest rate differentials have firmly favored the euro, with the single-currency up 7 percent year-to-date against the dollar.

The euro climbed to a session high of $1.4326 on trading platform EBS. In late afternoon New York trading, the euro pared some of its gains but was still up 0.4 percent at $1.4304.

A still unresolved debt restructuring issue in Greece, however, should minimize the greenback's losses against the euro, though the single-currency still managed to hold above its 55-day moving average, currently around $1.4295.

Jane Caron, chief economic strategist at Dwight Asset Management Company in Burlington, Vermont, said despite weak economic data, the June conclusion of the Fed's second round of quantitative easing, called QE2, should work in favor of the dollar.

The Fed's bond-buying program launched in November entailed buying $600 billion in Treasury securities.

"The weakness we have been seeing in the economy is due to shocks caused earlier in the year from Japan's earthquake and higher energy prices," she said. "We expect economic growth to reaccelerate in the second half of the year, but the Fed will likely be inclined to wait until 2012 to raise rates."

"An improving economy and the end of QE2 should ultimately push Treasury yields higher, and that will fare well for the dollar," she said.

Dwight Asset Management Company has $55 billion in assets under management.

Only 10 percent of economists and fund managers surveyed in a Reuters poll expected the Federal Reserve to launch another round of quantitative easing when the current one ends in June.

The euro has fallen in recent weeks after hitting a 17-month peak near $1.4940 in early May on expectations of a less aggressive ECB and concerns about debt in euro zone peripheral nations.

Traders said major central banks have been alternately buying the euro on dips and selling it on any modest rally, suggesting the single euro zone currency will trade within a tight range until the European Union and International Monetary Fund complete a full analysis of Greece's debt.

That analysis is due sometime in late May or early June and should shed light on whether Greece will restructure its massive liabilities.

Debt restructuring is viewed as negative for the euro as it could prompt a flight away from euro zone bonds and damage the European Union's credibility after it went all-out to bail out Greece.

The ICE Futures' dollar index was down 0.5 percent at 75.124 .DXY. The dollar was down 0.2 percent against the yen at 81.58 after hitting a three-week high at 82.179. Thursday's weak U.S. data had an impact on this currency pair.

(Additional reporting by Gertrude Chavez-Dreyfuss; Editing by Leslie Adler)

(This story has been corrected: in paragraph 9 to say EUR/USD is "above" 55-day average, not "trapped below"; in paragraph 8 corrects price to $1.4326, not $1.4325; in paragraph 9 to removes erroneous reference to fall below moving average and removes incorrect price information)