Dollar Hits 1-1/2 Year Peak on Global Rate Cuts Loom

The dollar raced to a 1-1/2 year peak versus a basket of currencies on Tuesday as investors bet that interest rates outside the United States could fall steeply to shore up global growth.

Concerns over the health of the global economy lured investors away from stocks into the safe-havens of the dollar, yen and Swiss franc. The Federal Reserve launched a new facility to provide liquidity to strained financial markets, which analysts said unnerved investors by highlighting continuing problems.

Analysts reckon aggressive interest cuts by the Fed and a possible stimulus package put the U.S. economy in a better position to recover quickly compared to its others around the world.

"We have seen the dollar strengthen across the board as a result of the mild sell-off in stocks. Most importantly the market is starting to shift its focus back to the underlying economic fundamental story, which is a dollar-positive story," said Omer Esiner, senior market analyst at Ruesch International in Washington.

"It suggests that the interest rate differentials will continue to be in the dollar's favor. The global economy is falling and lending rates abroad have more room to the downside than in the U.S. It suggests that the dollar's relative yield appeal will continue to improve."

The Federal Reserve has slashed its benchmark overnight lending rate by 3.75 percentage points to 1.50 percent, with the last 50 basis points easing coming early this month as part of a coordinated action with other major central banks.

In contrast, the European Central Bank has only lowered rates by 50 basis points to 3.75 percent and that step was part of the coordinated effort this month.

The ICE Futures U.S. dollar index climbed as high as 84.199 , its highest since March 2007, according to Reuters data. The index, which measures the greenback's value against a basket of six currencies, was last up 1.4 percent at 84.114.

The euro dropped to its lowest level against the dollar since March 2007, according to Reuters data.

Dollar Still in Demand

Analysts said despite further declines in interbank rates, there was still a healthy appetite for the dollar, particularly from financial institutions with exposure to the derivatives market.

"The one thing that remains clear is there is still a desire to get U.S. dollars and U.S. assets," said Matthew Strauss, senior currency strategist at RBC Capital Markets in Toronto.

"Although we have seen the funding situation easing somewhat, especially if we look at the Libor rates, it's still at elevated levels. Financial institutions that have direct exposure to the derivatives market are looking for a safe-haven."

The interbank cost of borrowing dollars, euros and sterling fell across all maturities on Tuesday, according to the British Bankers' Association's daily fixing. Dollar overnight rates were fixed below the Fed's 1.5 percent target for its federal funds rate.

The euro's break below some key technical levels against the dollar also added to the U.S. currency's momentum, analysts said, adding that the currency pair could drop as low as $1.3000 before staging a modest rebound likely to be capped around $1.3500 before year-end.

"As it breaks lower, short-term players are riding the trend and that in itself is adding to the momentum in the dollar," said Strauss.

Stocks fell due to worries about the outlook for profits, which buoyed the yen and the Swiss. Against the yen, the dollar fell. The euro dropped against the yen. The dollar fell against the Swiss franc.

A quarter-point interest rate cut by the Bank of Canada sent the Canadian dollar tumbling to a three-year low against the greenback. The dollar rose as high as C$1.2208.

The high-yielding Australian dollar fell 3.4 percent to US$0.6812 on expectations of further policy easing from the Reserve Bank of Australia.

RBA minutes from its meeting earlier this month indicated there was more room for rate cuts, though not as aggressive as this month's 100 basis point cut.

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