Dollar Gains; Risk Aversion Comes and Goes

The dollar and yen rallied against major currencies on Wednesday, reflecting heightened risk aversion as investors cut back on investments in higher-yielding assets, though gains eased as stocks rose.

A measure of the U.S. service sector slumped more than expected to a record low in November, keeping the dollar lower against the Japanese currency.

Currency moves were heavily influenced by expectations for interest rate decisions by central banks in the euro zone, Britain, New Zealand and Sweden, with expectations high of aggressive monetary policy easing to counter the threat of deflation.

Investors have flocked to the dollar and the yen on the view that the ECB, BoE and other central banks have more scope to cut rates than the Bank of Japan and the Federal Reserve, whose rates are already low.

"We speculate that the market is particularly nervous over the ECB decision tomorrow," said Stephen Malyon, senior currency strategist at Scotia Capital in Toronto in a note to clients.

"The discrepancy between what many believe the ECB should do, and what it is expected to do, has produced plenty of discord between economists over the outcome," Malyon said.

While the consensus call is for the ECB to cut by 50 basis points to 2.75 percent, there are many economists expecting a 75 basis point cut, and a not-insignificant number thinking the ECB could deliver a 100 basis point cut, Malyon said.

Midway through the New York session, the dollar slid versus the yen, , while the euro fell against the Japanese currency. Both pairs well off the session lows.

The low-yielding Japanese currency, which rose to a five-week high against the dollar according to Reuters data, had drawn strength from tumbling share prices but surrendered some gains as stocks in Europe and the U.S. turned positive.

Investors are continuing to unwind carry trades, where the yen was used to fund purchases of higher-yielding assets.

Analysts said the yen would take strength from falling share prices which suggest that risk aversion remains high.

The euro fell versus the dollar.

Though also off the session low, it was still struggling after data showed further deterioration in the euro zone's services sector.

Earlier in the day, bleak PMI services data for the euro zone pushed the euro to a session low against the dollar and the yen, as the figure provided further evidence that the single currency region is grappling with a recession.

Weak Services PMI

Sterling fell broadly after data showed that the UK services sector shrank faster than expected in November.

Sterling was down against the dollar.

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The purchasing managers' index (PMI) for the services sector fell to a series low of 40.1, boosting expectations that the Bank of England may slash rates by a full percentage point from 3.0 percent on Thursday to shore up the domestic economy.

Impacting Asian trading, China's central bank entered the domestic foreign exchange market on Wednesday to offer dollar liquidity, which pulled the yuan off the bottom of its daily trading band versus the U.S. currency.

However, many in the market believe China is adjusting its currency policy towards moderate yuan depreciation to stimulate the economy.

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