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Dollar Index at Six-Month High as Euro Stumbles

Friday, 1 Mar 2013 | 4:05 PM ET
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The dollar rose to a six-month high against a basket of currencies, buoyed by gains against the euro on growing evidence the U.S. economy was showing signs of improving even as the euro zone struggles.

Traders said poor economic data in the euro zone, along with cooling inflation and growing risks that political instability in Italy would push up borrowing costs for struggling European countries could combine to exert pressure on the European Central Bank (ECB) to lower interest rates in coming months. That is likely to keep the euro weak.

Interest rate spreads between two-year U.S. government bonds over their German counterparts were moving in favour of the former, offering another reason to investors to buy the dollar. More and more investors are expecting the Federal Reserve to slow its asset purchase programme later in the year as the U.S. labour market shows signs of improvement.

Investors were also focused on $85 billion in U.S. budget cuts that are due to start on Friday, although concerns about the impact on the world's largest economy could merely encourage investors to buy the highly liquid dollar as a safe haven.

Data on Thursday supported the dollar, showing a drop in new claims for jobless benefits in the U.S. last week and a sharp rise in factory activity in the Midwest. In contrast, joblessness in the euro zone rose to a all-time high while business surveys showed manufacturing activity was sluggish in February.

The dollar index last rose 0.4 percent to 82.29. Its gains came as the euro fell to near its lowest in nearly two months of $1.302, with option barriers at $1.3000 appearing vulnerable.

The euro posted its largest monthly fall against the dollar in nine months in February after an inconclusive Italian election.

"When you look across Europe, you see high unemployment, barely any growth, apart from Germany, and rising debt levels," said Howard Jones, advisor at money mangers RMG Wealth Management. "What Europe needs is growth and easier monetary conditions."

"The U.S. data in comparison is much better than Europe and to us, the dollar is a buy. We expect the euro to ease towards the mid-$1.20s in the next two months."

Speculation that the ECB may cut rates in coming months gathered pace after benign euro zone inflation data. That talk along with renewed worries about rising borrowing costs for struggling euro zone countries would make the euro a sell into rallies, analysts said.

"We are recommending clients to cautiously scale in long euro/dollar positions at this level. But we should not fool ourselves, this (Italian situation) could still go really bad," said Arne Lohmann Rasmussen, head of FX research at Danske Bank in Copenhagen.

Dollar on Top

A last-ditch deal to avert the U.S.budget cuts, due to start on Friday, is seen as highly unlikely.

The International Monetary Fund said it would probably cut its U.S. and global growth forecasts if those automatic spending cuts take effect on Friday, and warned that the United States' biggest trading partners would be hardest hit.

Despite the spending cuts hurting growth in the United States, the economy there is not expected to perform as badly as the euro zone, Britain and Japan, which are all battling recession or deflation, giving the dollar a boost.

"The end of 2012 has likely seen the low in real U.S. yields. This suggests the Fed is unlikely to do further easing measures," Deutsche Bank said in a note.

It added that even if the Fed did ease more, other central banks like the Bank of Japan were catching up with Fed easing, pushing down the value of their currencies against the dollar.

The dollar rose to a six-week high against the Swiss franc and was up 1.1 percent at 93.57 yen.

It also rose to a 2-1/2 year high against sterling after a shock contraction in manufacturing activity in February, raised expectations that the Bank of England will announce fresh monetary easing as early as next week. On Friday sterling fell below 1.50 for the first time since July 2010.

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