Dollar inches higher but prospects stay dreary

NEW YORK Fri Sep 20, 2013 4:37pm EDT

A photo illustration shows a $100 banknote placed above Chinese 100 yuan banknotes in Beijing May 10, 2013. REUTERS/Petar Kujundzic

A photo illustration shows a $100 banknote placed above Chinese 100 yuan banknotes in Beijing May 10, 2013.

Credit: Reuters/Petar Kujundzic

NEW YORK (Reuters) - The dollar on Friday edged up from this week's seven-month low, helped by comments from Federal Reserve officials suggesting a reduction in stimulus could be much closer than many thought.

St. Louis Federal Reserve President James Bullard didn't rule out a reduction in stimulus next month depending on U.S. economic data, while Kansas City Fed President Esther George, the lone dissenter on the Fed's policy decision, said the U.S. central bank had sowed confusion and risked the bank's credibility.

"The main takeaway from Bullard and George's comments today is that the Fed is keeping all of their options open and despite Wednesday's decision they are still very close to slowing asset purchases," said Kathy Lien, managing director at BK Asset Management in New York.

A tapering of the Fed's bond-buying program is viewed as positive for the greenback because it entails reducing the amount of dollars in the market, thereby boosting its value.

The greenback was also supported by a resurgence of caution given a looming Congressional battle over the U.S. budget.

Still the dollar's outlook, however, remained downbeat, after the Fed on Wednesday unexpectedly decided to keep its massive stimulus program intact for now, citing a still high U.S. unemployment rate and rising mortgage costs. That should ensure U.S. interest rates would remain low for a long time, diminishing the allure of dollar-based assets.

On the week, the dollar index posted its worst weekly performance in more than two months.

Samarjit Shankar, director of market strategy at BNY Mellon in Boston, said the bottom line is that the Fed's decision to stand pat on its stimulus "has further fuelled dollar pessimism and risk-on trades."

But Bullard, a voter on policy this year who has backed record stimulus, gave hope to the 'taper' enthusiasts, even though most economists now expect the Fed to reduce its bond purchases in December.

The dollar touched a one-week high against the yen and rose against the euro after Bullard's remarks. It was last little changed versus the yen at 99.37 yen, while the euro also traded flat versus the greenback at $1.3519, having hit a 7-1/2 month high on Thursday. On the week, the euro was up 1.7 percent, its best weekly showing since February.

The dollar index was last up 0.1 percent at 80.451 .DXY, a little above Wednesday's seven-month trough of 80.060.

Bullard said this week's decision not to taper was a close one and that low readings on inflation meant that the Fed can afford to be patient about the timing of a scale-back in its bond-buying program.

George, on the other hand, noted the "costly steps taken to prepare markets" in recent months for a policy change, and warned that the Fed's message has been muddled.

U.S. BUDGET SHOWDOWN

Investors, however, remained cautious not only about the scope and extent of the Fed's eventual exit from quantitative easing, but also the decision about Fed Chairman Ben Bernanke's successor and looming congressional budget battles, factors which could further weigh on the dollar.

A decision in the congressional battle between rival U.S. political parties over raising the U.S. debt ceiling to allow the government to keep borrowing money to pay its bills is expected to come to a head later this year.

Even closer is a congressional fight over the federal budget to avoid shutting down the government.

"The spotlight is on Washington and whether a group with a poor track record of working together cohesively can strike a budget deal in time to avoid shutting down the government," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington.

Analysts said the euro could see marginal impact from Germany's general election on Sunday.

Chancellor Angela Merkel is seeking a third term but there are doubts she will be able to maintain her center-right coalition, which could complicate her euro zone policy.

The euro was down 0.1 percent against the yen at 134.31 yen, not far from a near four-year high of 134.94 yen touched on Thursday.

(Additional reporting by Nick Olivari; Editing by James Dalgleish)