July 26, 2013 / 12:05 PM / in 4 years

FOREX-Caution before next week's Fed meeting hurts dollar

* Dollar index hits five-week low

* Traders cautious before Fed policy meeting next week

* Euro rises to 5-week peak versus dollar

By Jessica Mortimer

LONDON, July 26 (Reuters) - The dollar fell to a five-week low against a basket of major currencies on Friday on concerns that possible tweaks to the Federal Reserve’s forward guidance next week could keep interest rates lower for longer.

The dollar index fell 0.5 percent to 81.579, its lowest since June 20, just above chart support at 81.50 - its 200-day moving average and the 76.4 percent retracement of its June to early July rally.

Traders said a Wall Street Journal report that the U.S. central bank may debate changing its forward guidance to emphasise that it will keep rates low for a long time prompted investors to trim bets on the dollar gaining.

The latest falls caused the dollar to resume a slide that began on July 10, when minutes of the Fed’s June meeting gave investors second thoughts about when the bank would start reducing stimulus. Next week’s Fed meeting ends on Wednesday.

“We could see more squaring of long dollar positions keeping the downward pressure on the dollar ahead of the FOMC meeting next week,” said Niels Christensen, currency strategist at Nordea in Copenhagen.

He said investors were still long of dollars, particularly against the yen and emerging market currencies.

The euro rose to a five-week peak of $1.32975, helped by this week’s solid euro zone purchasing managers’ surveys. More gains could see it target the mid-June high of $1.34175.

Axel Merk, president and chief investment officer of Merk Investments, said the euro had the potential to rise to $1.40 this year and $1.50 next year because European Central Bank monetary policy was more restrictive than in the United States.

“The reason why the euro has been so strong is that the ECB has printed a fraction of what many others have printed. On top of that, the ECB’s balance sheet is shrinking and the euro zone does not have a current account deficit ... the currency has nowhere to go but up.”

The euro is around 10 percent higher against the dollar since ECB President Mario Draghi vowed a year ago to do “whatever it takes” to save the single currency, calming investors’ fears about the euro zone breaking up.

The dollar fell 0.8 percent to a two-week low of 98.485 yen , close to chart support at the July 11 low of 98.20 yen.

But the U.S. currency is expected to be well supported over the coming weeks on expectations the Fed will scale back asset purchases under its quantitative easing programme soon, perhaps as early as September.

Nordea’s Christensen said firmer U.S. data could quickly encourage market players to buy the dollar again. A University of Michigan sentiment survey is due at 1355 GMT, while the main focus will be on U.S. jobs data on Friday next week.

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