The dollar advanced broadly on Tuesday after Federal Reserve Chairman Ben Bernanke warned about the inflationary impact of a weak currency, suggesting the central bank is not likely to cut interest rates further this year.
In a speech before the International Monetary Conference Central Bankers' Panel in Barcelona, Bernanke said the Fed is carefully monitoring developments in the currency market.
"We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations and will continue to formulate policy to guard against risks to both parts of our dual mandate," he said, referring to the Fed's twins goal of ensuring sustainable growth and low inflation.
"This is a major shift for the Federal Reserve towards the U.S. dollar as Chairman Bernanke specifically mentions the importance of the currency for the Fed," said Andy Busch, global currency strategist at BMO Capital Markets in Chicago.
The remarks likely signal that the policy-setting Federal Open Market Committee is concerned about the impact of a weak currency on inflation, "and thus the likely reluctance of the interest rate-setting body to lower interest rates further," Busch said. "And perhaps signals that rates are poised to be raised in the future due to inflation," he added.
The interest rate futures market has priced in a 98 percent chance the Fed will hold interest rates at 2.0 percent at this month's meeting.
The euro fell to a nearly three-week low versus the dollar, after trading higher earlier. By midday trading, it was around $1.50, still down on the day. The dollar index rose to its highest since May 14. Against the yen , the dollar also rose.
Bernanke's remarks also indicated to many analysts that the U.S. government's long-standing tolerance for a weaker dollar because of its positive impact on economic growth is over.
"There is less of a sense of U.S. benign neglect, for the dollar decline is plainly no longer viewed as benign," said Alan Ruskin, chief international strategist at RBS Global Banking and Markets in Greenwich, Connecticut.
"It is a clear suggestion that the Fed has shifted from viewing dollar weakness as helpful for growth to a point where the negatives associated with inflation have become more important," he added.
Also on Tuesday, the dollar garnered support from data showing a surprise rise in U.S. factory orders for April.
New orders at U.S. factories rose by a sharper-than-expected 1.1 percent in April as strong demand for quickly used nondurable goods offset a dip in orders for costly durable goods.
Both Bernanke's speech and the U.S. data seem to have outweighed concerns about problems in the banking sector, a factor that pressured the dollar on Monday and earlier in the session.
On Tuesday, The Wall Street Journal reported that U.S. investment bank Lehman Brothersmay raise up to $4 billion in new capital, suggesting the firm could post its first quarterly loss since going public.
The news had compounded the market's risk aversion, which reappeared on Monday after Standard & Poor's cut its credit ratings on Lehman , Merrill Lynch and Morgan Stanley and said its outlooks on the large U.S. financial institutions were predominantly negative. The Lehman news fueled initial selling in the dollar.
A source familiar with the situation later told Reuters that Lehman has no need to raise capital and said capital-raising is just one of several options Lehman is considering. That helped boost U.S. equities, along with a drop in oil prices.