Dollar Slides Against European Currencies On U.S. Economic Data

The dollar slipped against European currencies after a batch of solid U.S. economic data did little to shake expectations the Federal Reserve would keep interest rates steady for some time.

The New York session began with the dollar gaining modestly on December data showing a stronger-than-expected gain in core producer prices, weakening the case for a near-term cut in U.S. interest rates. However, the index rose at a slower pace than in November.

Another report showed U.S. industrial output expanded more than expected last month, fueled by robust increases in manufacturing and mining, although November's output was revised lower.

"Overall, the batch of U.S. economic reports earlier today supports a continuation of the Fed's steady rates monetary policy," said Alex Beuzelin, senior market analyst, at Ruesch International in Washington.

The interest rate futures market has fully priced in expectations the Fed will keep rates unchanged at 5.25% at its January and March meetings, and is not confident about a rate cut before the third quarter.

Beuzelin noted that the dollar's turn lower was more of a technical move. "I think $1.2880 is the key target for euro/dollar. We were unable to make a serious run for that level, so we're seeing the dollar pull back a little bit."

The dollar held its gains after a report showed net capital inflows into the United States in November were more than enough to cover the U.S. trade deficit for that month.

"The headline number (excluding swaps) was a little disappointing, but given a few months now of decent improvement in the U.S. trade deficit, I don't think it's too significant a development," said Shaun Osborne, chief currency strategist, TD Securities in Toronto.

"The trade deficit was well covered so I think that's another plus for the dollar," he added."

Against the yen, the dollar was little changed  ahead of the Bank of Japan's monetary policy decision on Thursday. The yen had been under recent pressure as expectations for a rise in interest rates from the BOJ faded following media reports it was unlikely to act this week.

This morning, Reuters quoted an unnamed source as saying the BoJ will probably hold off raising interest rates at its policy meeting.

Earlier this week, investors had braced for a BOJ rate rise to 0.5%, despite some signs of political pressure on the bank to leave rates unchanged.

However, those expectations quickly faded after Kyodo news agency, the Nikkei business daily, and others reported that the BOJ was likely to keep rates on hold this week.

The chance of a BOJ move on Thursday was slashed to about 30% from 80% a day earlier, according to overnight index swaps, which are contracts based on the outlook for short-term rates.

"There's currently no urgency for the BoJ to raise rates," said Ruesch's Buezelin. "If you look at the recent run of Japanese economic reports, inflation remains very benign. The data have also shown a moderation in Japanese economic activity, particularly on the consumer spending side."

The euro, meanwhile, earlier touched a fresh 2-1/2 year low against sterling, at 65.61 pence, according to Reuters data, on expectations last week's surprise UK rate hike could be followed by another move soon.