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Dollar Weakens as U.S. Subprime Continues to Nag

The dollar slipped for a second session Wednesday, hitting a fresh record low against the euro, as problems in the U.S. subprime mortgage market continued to weigh on the currency.

The dollar also fell to a 26-year low against sterling and a one-month trough against the yen, still reeling after two ratings agencies Tuesday started to slash ratings on more than $17 billion of debt linked to risky mortgages.

The yen's gains reflected the market's nervousness, with investors unwinding some carry trades, in which low-yield currencies including Japan's are sold for high-return units such as the New Zealand dollar. On Wednesday, the New Zealand dollar dropped against the yen, a two-week low.

"Risk aversion is coming back into play on the back of the subprime debacle. And we're seeing some unwinding of carry trades," said Ron Simpson, director of currency research at Action Economics in Tampa, Florida.

"U.S. Treasury yields have come down and that has weighed on the dollar. The market is still focused on interest rates and in an environment where most G7 (central banks) are in a tightening mode, the Federal Reserve is on hold," he added.

Early in New York, the euro was up on the day against the dollar, having earlier set a record high of around $1.3787, according to electronic trading platform EBS.

The euro rose against the yen. The euro drew support from comments by European Central Bank President Jean-Claude Trichet, who signaled more interest rates hikes. He said the ECB's monetary policy remained on the accommodative side and that the bank will monitor developments closely.

Sterling was up versus the dollar, after hitting a 26-year peak of $2.0351, while the dollar recovered from a one-month low of 120.99 yen to trade up slightly on the day.

The dollar recovered from its lowest levels, but it failed to gather enough momentum sufficient to reverse the dollar's losses.

Shaun Osborne, chief currency strategist at TD Securities in Toronto believes there could be more two-way action in the dollar on Wednesday after the currency took a pounding the previous day. He cited the narrowing in the interest rate spread between U.S. and euro zone two-year bonds in the dollar's favor.

"We'll probably try to establish a range today. The slight narrowing in the two-year differential between the U.S. and euro zone could support the dollar but only temporarily," Osborne said.

The dollar's sell-off on Tuesday was exacerbated by reports from Standard & Poor's and Moody's Investors Service that warned of ratings cuts on $17 billion of debt related to risky mortgages, much of it subprime. Subprime loans are extended to borrowers with poor credit.

U.S. subprime worries prompted markets to price in a greater risk of a Federal Reserve interest rate cut this year or next.

In contrast, other central banks around the globe are expected to continue tightening monetary policy, with yield differentials thus set to move to the detriment of the dollar.

The Bank of Japan is widely expected to hold interest rates steady on Thursday, although some of the more hawkish members of the board may vote for a hike to 0.75%.

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