Dollar, yen fall as credit markets ease; euro rises

NEW YORK (Reuters) - The U.S. dollar had its worst day against the euro in three weeks on Monday, while the yen weakened broadly, as credit conditions eased after major central banks unleashed a slew of measures to rescue a distressed global financial system.

The euro and sterling were also boosted after governments in Britain, France, and Germany announced plans to recapitalize their banking systems.

The improvement in risk appetite has been Monday's overriding theme as the Federal Reserve, the European Central Bank, Bank of England, and Swiss National said they would provide commercial banks with as much U.S. dollar liquidity as they needed at fixed rates to unlock clogged money markets.

"The whole idea that the dollar is benefiting from frozen credit markets is now starting to dissipate," said Brian Dolan, chief FX strategist, at Forex.com in Bedminster, New Jersey.

"The euro has therefore recovered and it's also a function of the fact that Europe's banking plan is out. That explains the euro's move to near $1.37."

Over the last two months, the dollar has benefited from the extraordinary tightness in money markets. With global business transactions still carried out in dollars, higher money market rates have underpinned the greenback as banks and funds jostled to buy dollars in efforts to stay liquid.

Market participants further assumed that the United States is the safest place for investors should a global economic slowdown worsen because the government has initiated bold moves to stem the bleeding in financial markets well ahead of the other monetary authorities.

In late trading, the euro rose to $1.3592, up 1.3 percent, its best day since September 22, according to Reuters data. The single currency was more than a cent off its session peak but well above Friday's low of $1.3257, its weakest level since March 2007.

Tokyo and Canadian bourses including the New York bond market were closed for national holidays, curbing volume.

YEN WEAKENS AS RISK APPETITE IMPROVES

Against the yen, the euro climbed 2.4 percent to 138.31. The dollar rose 1.1 percent to 101.76 yen.

Aside from the dollar, the yen has been a major beneficiary of increased risk aversion in the last few months amid troubles in the global financial sector. Investors have unwound billions of dollars in risky carry trades financed using the yen's ultra-low rates, bolstering the Japanese currency.

"What we're going to see in the coming days and weeks is a rebound in risk appetite and this is going to lead to a lower yen," said Forex.com's Dolan.

In line with the decline in risk aversion, the interbank cost of borrowing in dollars, sterling, and euros all fell. Three-month euro Libor posted its biggest fall this year, three-month dollar Libor had its steepest drop since March, and Euribor rates eased across the board.

Global stock markets also rallied, while U.S. equities surged following their worst week on record, posting their best day ever.

Sterling rose 1.8 percent to $1.7350 after slumping to a five-year low near $1.68 on Friday. Britain said it would pour $64 billion into three of its biggest banks as part of a plan to restore confidence, helping a recovery in the pound. France and Germany also unveiled plans to recapitalize their banks.

The United States, which adopted a $700 billion rescue plan earlier this month, said it too would take stakes in banks, its first such move since the Great Depression. Australia also said it would guarantee deposits in its banks.

Australia's move helped turn sentiment on its currency, which rose 8.3 percent against the U.S. dollar to US$0.6965. Analysts expect further gains in the Australian dollar given how far it has fallen this year. The Australian currency has lost 20.5 percent so far in 2008 versus the greenback.

"Currently, the dollar seems a bit overextended. Now we don't want to ignore the potential for serious capitulation among dollar bears," said Jack Crooks, president of advisory firm Black Swan Capital in Palm City, Florida.

"But if stocks really find a chance to bounce then the risk-aversion flow that has weakened stocks and strengthened the dollar could quickly reverse course. This could mean sharp inflows to currencies like the Australian dollar."

(Additional reporting by Steven C. Johnson;)