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Dollar Drops on Outlook for Higher European Interest Rates

Reuters
Wednesday, 23 May 2007 | 10:27 AM ET

The dollar fell after minutes from a Bank of England policy meeting and strong data on euro-zone industrial orders suggested interest rates in Europe could rise more than previously thought.

The pound surged against the dollar after the BoE minutes showed that contrary to expectations the central bank's decision to raise rates this month was unanimous, and some members even considered a half percentage point rise.

The euro followed suit, getting a boost from data that showed a surprisingly large surge in euro-zone factory orders in March. The market is already pricing in two more quarter point rate rises from the European Central Bank this year to 4.25%, but the chances of further hikes are rising.

"There's been a complete readjustment of interest rate expectations that caught everyone flatfooted and now you're starting to see some short-covering and the dollar strength that we've seen getting reversed," said Boris Schlossberg, senior currency strategist at DailyFX.com in New York.

In New York, the euro was up , around two cents below a record peak touched last month. Sterling was , having rallied more than one cent after the release of the minutes.

Elsewhere the Canadian dollar hit a fresh 29-1/2 year high of 1.0817 to the U.S. dollar, extending a rally driven by rising oil prices and an ongoing bidding war by foreign suitors for Canadian companies in the natural resources sector.

The dollar's decline was its first in three sessions. The greenback has rebounded over the past month as a crop of robust U.S. economic data has led the market to pare back expectations that the Federal Reserve will cut interest rates this year.

Eurodollar futures are reflecting around a 60% chance that the Fed will lower interest rates from 5.25% by the end of 2007, in contrast to earlier this year when more than one quarter point rate cut was fully priced in.

The next big focus for economy watchers will be U.S. durable goods and housing reports due on Thursday.

The dollar was barely moved against the yen . But the Japanese currency took a beating against the euro, sterling and Australian dollar.

Given expectations that Japanese interest rates are set to remain the lowest in the industrialized world for some time to come, low volatility and buoyant equity markets around the world have encouraged investors to keep selling yen for higher-yielding assets in so-called carry trades.

The MSCI All-Country World Index, a barometer of global stock prices, hit a record peak, driven by fresh highs in bourses ranging from Shanghai to Frankfurt.

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