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Dollar Sinks to 26-Year Low vs. Pound, Nears All-Time Euro Trough

The dollar dropped to a 26-year low against sterling and traded near a record low versus the euro on Wednesday, as expectations for U.S. interest rate cuts contrasted with prospects for monetary tightening in Europe and Asia.

The greenback later turned slightly higher against the pound, trimmed early losses against the euro and fell against the yen.

"There's been a slight dollar (selling) pullback. I think some major levels have been touched upon, so we're seeing some profit-taking on short dollar positions," said C.J. Gavsie, managing director for FX sales at BMO Capital Markets in Toronto.

"But interest rate expectations remain the fundamental driver in this market", which should weigh on the dollar, Gavsie said. BMO is looking for a slight increase in Japanese rates, hikes from the European Central Bank and Bank of England, and mostly steady to lower rates in the United States in coming months.

For the rest of the week, analysts expect dollar weakness to remain the dominant theme since there are no Federal Reserve officials scheduled to speak and no major market-moving U.S. economic data due for release.

The pound, which rose above $2 on Tuesday for the first time since 1992, on Wednesday scaled levels last seen in June 1981. In that year, the pound had fallen sharply from a high
above $2.40 hit in January 1981.

Sterling rose as high as $2.0133 on expectations the BoE will raise interest rates by at least 25 basis points to 5.5% in May, which would top the U.S. federal funds rate.

The euro also slowly approached historic highs versus the dollar, rising above $1.3600 for the first time in two years and coming within 60 ticks of record peaks set in December 2004.

The euro was flat at $1.3574, and down from its peak of $1.3616.

The greenback also held near Tuesday's 17-year low against the Australian dollar.

Demand for the dollar dwindled after Tuesday's data showed tamer-than-expected U.S. consumer price inflation for March, excluding food and energy. The data contrasted with a jump in UK consumer prices, which stoked expectations for a rate hike.

"The outlook for interest rates in the U.S. contrasts sharply with that for the rest of the world, in particular the UK and the euro zone," said Omer Esiner, market analyst at Ruesch International in Washington. "That simple reality is very bearish for the dollar."

Investors also continued to shift funds to the euro after the ECB Bank kept rates unchanged at 3.75% last week but suggested it was likely to tighten credit in June or beyond to stem higher inflation.

On Wednesday, ECB Governing Council Member Axel Weber reiterated the bank's inflation concerns, saying the risk of stronger increases in German wages has risen and with it the chance of pass-through inflation effects.

By contrast, most economists expect the Fed to cut its benchmark rates sometime this year, even though the U.S. central bank has reiterated its main concern remains price pressures.

The yen, which has suffered recently along with the dollar due to its low-yielding status, pulled back from a record low against the euro as investors took profits on short positions.

Investors have used the yen as a funding vehicle for carry trades, which involve selling a low-yielding currency to invest in higher-yielding assets.

"Yen strength has been one of the major drivers today. I think we're just seeing some rebalancing of these carry trades," said BMO's Gavsie.

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