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Dollar Fails to Recover From China Currency Reserves Comments

The dollar fell sharply against the yen, surrendering earlier gains after a magazine reported that China would stop stockpiling foreign exchange reserves.

But analysts said People's Bank of China Governor Zhou Xiaochuan might have been misquoted, since China's $1 trillion stash of reserves will keep growing as long as its central bank keeps buying dollars to keep the yuan from appreciating, a practice it has shown no sign of abandoning any time soon.

Zhou was quoted by Emerging Markets magazine, a Euromoney publication, as saying "many people say that foreign exchange reserves in China are (already) large enough. We do not intend to go further and accumulate reserves."

The magazine was released during a meeting of the Inter-American Development Bank in Guatemala.

"Most people in the market just assumed he was misquoted and the intention wasn't that they were going to stop accumulating reserves, but more that they would stop accumulating reserves in the same way as they are now," said Camilla Sutton, foreign exchange strategist at Scotia Capital in Toronto.

The dollar dipped as low as 116.90 yen, down 0.5% from levels seen late Monday. The greenback peaked at 118.01 yen in overseas trade.

The euro was lower after hitting 156.96 yen earlier. Against the dollar, the euro traded up slightly.

Sterling rallied broadly after above-forecast inflation data boosted the case for higher British interest rates, while the dollar fell 1.2% against its Canadian counterpart to a three-week low.

Excuse To Sell Dollars

Analysts said there appeared to be nothing new in Zhou's remarks and added that short-term investors simply used them to unwind long dollar trades built up Monday when global stock markets rebounded and carry trades came back into vogue.

"If he'd said they were going to let the yuan float, that would have been a significant change in China's currency management strategy," said David Watt, senior currency strategist at RBC Capital Markets in Toronto. "But I don't think what he actually said was all that significant."

China's reserves are already the world's largest and have been growing at a brisk pace as China buys foreign currencies -- mainly dollars -- to keep the yuan from rising beyond the top of a tight trading band.

Analysts noted that China would still be accumulating reserves in a new investment agency which is expected to manage some $200 billion of assets.

Watt said recent volatility, the result of trouble in the U.S. subprime mortgage market in particular and rising risk-averse behavior in general, also contributed to Tuesday's choppy trade.

"People are just tightly wound right now, and almost anything causes a market reaction," he said. "In a period of lower volatility, I don't think Zhou's comments would have had any impact whatsoever."

Investors were also looking ahead to Wednesday's conclusion of the Federal Reserve's two-day policy meeting, expected to end with the federal funds rate unchanged at 5.25%.

Any mention of equity turmoil or a shift in the Fed's bias toward tighter monetary policy could weigh on the dollar.