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Dollar Sells off on Record U.S. Trade Deficit, Strong European Growth

The dollar fell sharply against the euro after a wider U.S. trade deficit in December raised worries about downward revisions to growth.

Meanwhile, better-than-expected euro zone growth in the final three months of 2006 helped push the euro back above the $1.30 threshold and bolstered expectations for another interest
rate hike next month from the European Central Bank.

"The trade data does raise concerns, as we've seen a string of strong U.S. data and maybe now we're seeing some holes creeping in," said Steven Butler, director of foreign exchange at Scotia Capital in Toronto.

Doug Smith, chief economist for the Americas at Standard Chartered in New York, said the trade numbers "might slice a little" off U.S. gross domestic product, which he said could get revised down 1.2 to 1.3 percentage points.

The government's first estimate saw the U.S. economy growing at a hearty 3.5% pace in the fourth quarter of 2006.

Overnight, a report showed the 13-country eurozone grew at a 0.9% pace in the October-December period, above expectations of a 0.6% reading.

Data from the zone's three top economies -- Germany, France and Italy -- also surprised to the upside, leading to increased euro bids and further supporting the view that euro zone
interest rates will rise in March.

The yen approached a four-year low versus the dollar on Monday after Group of Seven leaders wrapped up a weekend meeting without sounding a formal alarm about yen weakness.

European leaders have complained about a weak yen and warned against excessive one-way currency bets, a favored strategy in which investors borrow yen cheaply, buy higher-yielding assets, and profit on the spread.

Known as the carry trade, it has been a key reason for chronic yen weakness.

But with Japan due to release growth data on Thursday that many think may surprise to the upside, traders were unwinding some of their bets against the yen.

"The market is a little concerned about taking carry trades too far," Butler said. "Even with the G7 not saying anything, you have to be a little cautious staying overweight carry trades."

UBS currency strategist Daniel Katzive said the yen may have been lifted by news that the six-party talks about North Korea's nuclear disarmament have produced a tentative pact.

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