March 20, 2009 / 12:15 AM / 11 years ago

Dollar caps worst week in 24 years

NEW YORK (Reuters) - The dollar rebounded on Friday but still recorded its biggest weekly slide since 1985 as the Federal Reserve’s plans to buy long-term government debt stoked fear about the erosion of the U.S. currency.

A bank employee counts one hundred dollar notes at a bank in Seoul February 26, 2009. REUTERS/Lee Jae-Won

The Fed shocked financial markets this week when it said it would buy some $1 trillion of government and mortgage-backed debt in a bid to cut interest rates and kick-start lending.

Anticipating an oversupply of dollars, traders sold the greenback broadly. The euro hit a two-month high above $1.37 en route to its biggest daily gain since its 1999 launch.

The dollar clawed back some of its losses on Friday, but against a basket of currencies.DXY it still notched its biggest weekly plunge since the 1985 Plaza Accord, when major economies agreed to a formal depreciation of the greenback.

“I think we will look back at this week and see it as seminal one because the Fed changed the way markets perceive monetary policy and the dollar,” said Mike Moran, senior currency strategist at Standard Chartered Bank in New York.

But while the dollar has taken a hit, he said a severe global recession will continue to hurt other countries and their currencies, too. “That means we’ll see a lower range for the dollar rather than a total meltdown, which is what the market is getting its head around today.”

The euro fell 0.7 percent on Friday to $1.3563, after hitting a peak of $1.3737 on Thursday, its highest level since early January. At current prices, the common currency was up more than 5 percent from last Friday’s $1.2922 close.

Data showing euro zone industrial output fell in January for a fifth straight month underscored the economy’s woes and chipped away at the euro’s recent gains.

The dollar was up 1.5 percent at 95.87 yen but down 2.2 percent on the week, while sterling fell 0.5 percent to $1.4439 but ended the week 3.4 percent firmer.

PRESSURE TURNS TO ECB

Moran said a weaker dollar will cause headaches for other economies, including in Asia and Europe, as it lifts the value of their currencies in a recession and raises deflation risks.

That is what the Fed and central banks in Britain, Japan and Switzerland are seeking to avoid by cutting interest rates to zero and flooding their economies with money.

The Swiss National Bank even entered currency markets last week to sell the franc. When it drifted higher again this week against the dollar and euro after the Fed’s move, SNB President Jean-Pierre Roth knocked it down on Friday, saying deflation risks make it important to keep the franc from appreciating.

All of this, analysts said, puts pressure on the European Central Bank, which still has interest rates at 1.5 percent.

Strategists at UBS said the euro’s rise this week amounts to “an effective tightening of monetary policy” and threatens euro zone companies’ overseas earnings.

“We believe the ECB will need to shift its rhetoric as soon as possible,” they wrote in a research note, adding they expect the central bank to cut euro zone rates to 1 percent in April.

In the days ahead, though, the euro may add to this week’s gains, particularly if stock markets can resume a recent rally that ran out of steam on Friday.

Boris Schlossberg, head of currency research at GFT Forex in New York, said the euro may rise above $1.40 next week.

Jessica Hoversen, a fixed-income and currency analyst at MF Global, Ltd, in Chicago, said: “We are not convinced that the dollar selling is over.”

Additional reporting by Vivianne Rodrigues; editing by Leslie Adler

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