March 19, 2009 / 6:27 PM / 10 years ago

FOREX-Dollar plunges in fallout from Fed Treasury plans

* Dollar extends losses after biggest slide since 1985

* Fed to buy govt debt, flooding markets with dollars

* Emerging markets currency, high yielders rise

* Pressure on ECB to act may eventually reverse moves

(Updates prices, adds detail, comment, changes byline)

By Steven C. Johnson

NEW YORK, March 19 (Reuters) - The dollar fell for a second straight session on Thursday and the euro soared above $1.37, as investors feared the Federal Reserve’s Treasury bond purchases would end up debasing the world’s reserve currency.

The Fed said on Wednesday it will purchase $300 billion of long-dated Treasuries over the next six months, its first large-scale buying of government debt since the early 1960s.

It also said it will increase mortgage-backed debt purchases in a bid to rescue the economy, sending the dollar to its worst one-day loss since at least 1985 and sparking the biggest slide in U.S. benchmark Treasury bond yields since the 1987 stock market crash.

This raised fears that an expansion of the Fed’s balance sheet — which has doubled in size in the past six months — would lead to oversupply of the world’s main reserve currency.

“They are really cranking up the printing press, and that’s hurt the dollar,” said Andrew Wilkinson, senior market analyst at Interactive Brokers Group in Greenwich, Connecticut.

“The knee-jerk reaction is still to sell dollars, and that will probably see the euro rise into the $1.40s,” he said.

The euro rose as high as $1.3737 EUR=, its best level since early January, and was last up 1.1 percent at $1.3650. On Wednesday, its 3.8 percent rise against the greenback marked its best day since its 1999 launch, according to Reuters data.

The dollar fell 1.5 percent to 94.45 yen JPY= after shedding nearly 3 percent a day ago, while sterling was at $1.4524 GBP=, up 1.3 percent.

The dollar index .DXY, which measures the greenback against a basket of six major currencies, slipped 1.3 percent after a 3 percent plunge on Wednesday, its biggest one-day drop in about of a quarter of a century, according to Reuters data.

OPTIMISM RUN AMOK?

The Fed’s move also seemed to reduce widespread fear in financial markets, undermining the safe-haven bid that has supported the dollar over recent months.

Currencies seen as more risky just days ago given the deteriorating global economy rose smartly on Thursday, among them the Australian dollarAUD=, Norwegian crown NOK=, Brazilian real BRL= and the Mexican peso MXN=.

“Fear seems to have gone out the window,” Wilkinson said.

Some strategists said that view is probably too optimistic and predicted a more sober outlook on the U.S. and world economies once the post-Fed dust settles.

Fabian Eliasson, vice president of currency sales at Mizuho Corporate Bank in New York, said the worries about Japan’s economy would soon lead to renewed yen selling.

The euro, he said, also looked vulnerable above $1.40. “Europe still has a lot of skeletons in the closet,” particularly a severe recession in east Europe that is likely to get worse before it gets better, he said.

Indeed, UBS strategists said the bank opened a long dollar trade against the euro at $1.37 and the yen at 94.00 on Thursday, adding that they expect bond yields around the world to follow U.S. yields lower in the coming weeks.

The Fed’s move, along with earlier moves by central banks in Britain, Switzerland and Japan, may also force the European Central Bank to cut interest rates further toward zero and move toward its own extraordinary measures to boost growth.

“The last thing the ECB wants to see the euro above $1.40, let alone $1.50,” said Bank of New York-Mellon senior currency strategist Michael Woolfolk.

Additional reporting by Vivianne Rodrigues; Editing by Chizu Nomiyama

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