May 20, 2009 / 8:32 PM / 10 years ago

FOREX-US dollar slumps to 5-month low as risk appetite returns

* US dollar index near 5-month low, euro near 5-month peak

* Fed mulled increasing buying Treasuries

* Geithner says financial system healing

* Sterling rises to six-month peak vs dollar (Recasts; adds comments, updates prices)

By Wanfeng Zhou

NEW YORK, May 20 (Reuters) - The U.S. dollar fell to its lowest in nearly five month against major currencies on Wednesday as optimism about the economy dampened safe-haven demand and the Federal Reserve said it mulled buying more securities at its last policy meeting.

Investors’ appetite for risk in other currencies improved after U.S. Treasury Secretary Timothy Geithner said the financial system was “starting to heal” thanks to the government’s bailout efforts. A successful share offering from Bank of America (BAC.N) aided the positive sentiment in the markets earlier. For full story, see [ID:nN20501612]

The greenback extended declines after the minutes of the Fed’s latest policy meeting showed the central bank had considered increasing purchases of mortgage, agency, and government securities to spur the economy, a move that would inject even more dollars in the world’s financial system. [ID:nWEQ001023].

“The key thing we are taking away from the minutes is the commentary that some policy makers saw the need for buying more toxic assets, and if that happens, the market is going to be flooded with dollars,” said Matt Esteve, a foreign exchange trader at Tempus Consulting in Washington.

“That’s why we are seeing this knee-jerk reaction of traders selling the dollars versus most major currencies,” he added.

The ICE Futures’ dollar index_.DXY, which tracks the dollar’s movements against six major currencies, fell as low as 80.909, its lowest since early January. The dollar index has lost nearly 7.0 percent since it hit a near one-month high last month.

Michael Woolfolk, senior currency strategist at Bank of New York Mellon in New York, said money was flowing out of dollar-denominated deposits and going back into higher-risk assets.

“Overall, this is still a green-shoots rally. It’s evident in crude oil above $60, it’s evident in stocks, and it’s to some extent being driven by animal spirits,” he said.

In late trading in New York, the euro surged 1.1 percent to $1.3774 EUR=, having climbed as high as $1.3830, according to Reuters data.

Adding to gains in the euro were remarks from Portugal’s Finance Minister Fernando Teixeira dos Santos that a stronger euro, which has gained more than 3.0 percent against the dollar in the past month, had not been a concern among European finance ministers. [ID:nLK330989]

Against the yen, the euro fell 0.3 percent to 130.49 yen EURJPY= and the dollar last traded down 1.3 percent at 94.71 yen JPY=, after falling to as low as 94.69 yen.

STRONG RISK APPETITE

The Fed also cut its forecasts for U.S. economic growth and raised its unemployment rate outlook, tempering the recent optimism that the economy might be turning the corner.

But analysts said currency investors largely shrugged off the Fed’s more bearish view on the economy and focused on the possibility of further asset purchases.

“Risk appetite in the currency market is nothing short of impressive considering the fact that the Fed reduced their growth forecasts,” said Kathy Lien, director of currency research at GFT Forex in New York, in a note.

“Instead, the possibility of further asset purchases is weighing on the dollar because contrary to popular belief, we may not have seen the last of the Federal Reserve monetary stimulus.”

In other currency trading, sterling GBP=D4 rose sharply to hit a six-month peak versus the dollar and was last at $1.5746, up more than 1.8 percent on the day. (Additional reporting by Vivianne Rodrigues)

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