Dollar slumps 1% as China worries muddy US rates outlook

Frank van den Bergh | E+ | Getty Images

The dollar tumbled more than 1 percent against the euro and the yen on Friday as strikingly weak Chinese factory data fanned global growth worries and cooled betting that the Federal Reserve will raise U.S. interest rates next month.

Chinese manufacturing activity shrank at its fastest pace in 6-1/2 years in August, compounding investor concerns over slowing growth in the world's No. 2 economy and ignited sell-offs in equities and commodities.

Markets had been reckoning that a solid U.S. economy could prompt the Fed to raise rates for the first time in nearly 10 years as soon as September. However, soft Chinese economic data, sliding commodity prices and unconvincing U.S. inflation data have dulled expectations of a near-term U.S. rate hike.

Higher rates would raise borrowing costs for consumers and companies, possibly hurting spending and economic growth.

Dollar under pressure
Dollar under pressure

One indicator of Fed policy expectations, interest rates on overnight indexed swaps, suggested traders now see a 27 percent chance of a rate hike next month, down from 32 percent on Thursday and off from 48 percent a week earlier, according to data from inter-dealer money broker Tullett Prebon.

The euro, which is used as a 'funding' currency borrowed to buy riskier but higher-yielding emerging market currencies, easily topped $1.13 as investors reversed such trades and bought it back.

The euro was last trading against the dollar at $1.1367, up 1.16 percent. Earlier the euro hit a session high of $1.1375, last touched on June 22.

Data showing euro zone business growth unexpectedly accelerating this month gave the euro a brief boost, but most investors reckon China volatility and other external factors are more important drivers at the moment.

The dollar index of major currencies traded against the greenback was down for a third day and was last off 1.07 percent to levels last seen on June 30.

Read More Banks braced for billions in civil claims over forex rate rigging

Against the yen, which is also used as a funding currency and is a more traditional safe haven, the dollar fell to its weakest in six weeks at 121.81 yen, and was last down 1.07 percent at 122.12.

"Receding expectations for the Fed to raise rates at its coming meeting on Sept. 16-17 wield the potential to weaken the dollar further over the short run," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington. "However, a door seen as still ajar to a move next month should help limit losses in the dollar."