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Dollar Up on Year-End Buys, Europe Slowdown

The dollar rose against the euro and surged to a three-month peak against sterling Wednesday amid signs that financial market turmoil was starting to threaten economic growth beyond U.S. borders.

Exchanging Dollars and Euros
Exchanging Dollars and Euros

The euro was hit after an index of German business sentiment came in close to a one-year low, prompting investors to increase year-end dollar buying.

Large institutional investors also helped pushed sterling below the $2.00 threshold for the first time since September, with traders pricing in another interest rate cut after minutes from The Bank of England's last meeting earlier this month showed unanimous support for a cut to 5.5 percent.

"A tremendous amount of subprime mortgage debt was bought by British and European banks, and while the subprime crisis was U.S.-made, its effects are global. I think markets are realizing that," said Boris Schlossberg, senior currency strategist at DailyFX.com.

Volumes were typically light ahead of year-end and traders said that aggravated some of the price action.

Dollar buyers were also cheered by Morgan Stanley's announcement of a $5 billion investment from China, which drew attention away from writedowns that caused the bank to post a net loss of $3.59 billion in the fourth quarter.

In mid-afternoon trading, the euro was 0.3 percent weaker at $1.4365, near its $1.4327 session low hit overnight.

The British pound hit a three-month low at $1.9930 before recovering to $1.9962, still down nearly 1 percent from late Tuesday.

Strong demand for the Federal Reserve's $20 billion auction, part of a coordinated effort by major central banks to ease a credit crunch in the money markets, saw the dollar trim losses against the yen.

The dollar last traded at 113.26 yen, unchanged on the day, after dipping below 113 earlier.

"The [auction] news was very mild, nothing too positive or too negative. There seems to be a little bit of risk taking as fears of bad news were not entirely confirmed," said David Powell, currency analyst at IDEAglobal in New York.

The New York Board of Trade's U.S. dollar index, which tracks the greenback's performance against a basket of six major currencies, rose 0.3 percent to 77.625.

No Confidence

The weak business confidence reading in Germany came at a time when inflationary pressures were rising in the euro zone, suggesting that the European Central Bank may have a tough time raising rates any time soon, analyst said.

Such a situation could help the dollar regain further lost ground against the euro, with analysts less optimistic that the Fed would aggressively cut interest rates next year after inflation data last week pointed to lurking price pressures.

"The Ifo survey...highlights the difficult situation that the ECB is going to face in the medium term: a slowing euro zone economy and rising price pressures," said Omer Esiner, forex analyst at Ruesch International in Washington.

But Schlossberg said the ECB "is still erring on the side of inflation. They are far more concerned about price pressure than a slowdown."

With signs the rate-tightening cycle has peaked elsewhere in the developed world, Schlossberg said the ECB's "uber-hawkish" stance on inflation means investors "still favor the euro."

The Bank of Canada and Bank of England have already cut rates this year, and both are seen as likely contenders to cut again in early 2008.

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