Dollar Falls on Modest U.S. Inflation Data; Pound Sets 15-Year High

The dollar sank to a fresh two-year low against the euro on Tuesday after data showed U.S. core consumer prices rose less than expected in March, bolstering expectations the Federal Reserve may be more inclined to cut interest rates this year.

The dollar also dropped against the yen and sterling, which breached $2 for the first time in almost 15 years as UK inflation data cemented expectations the Bank of England will raise rates next month.

Tuesday's economic releases renewed worries among investors the U.S. economy may be slowing, compared with solid growth in other regions such as Europe and Asia, analysts said.

"The outlook for the U.S. economy and for interest rates just does not bode well for the dollar," said David Durrant, chief strategist at Julius Baer Investment Management. "Investors are at a point where they'd rather send money abroad where rates of return are much higher."

In afternoon trading, the euro was up 0.3%, after touching a two-year high of $1.3595, less than 1 cent below a record high of $1.3670.

The dollar sold off after data showed U.S. core consumer inflation grew just 0.1% in March, lower than market forecasts for a rise of 0.2%. In another report, U.S. March industrial output fell 0.2%.

After the data, the interest rate futures market was factoring in a quarter-percentage-point ease by year-end in the benchmark federal funds rate, currently at 5.25%, and was leaning more toward a second cut.

By contrast, the European Central Bank, although it kept benchmark interest rates unchanged at 3.75% last Thursday, has signaled it is likely to raise rates in June or beyond to stem higher inflation.

"We've seen some yen buying. I think we've had a nice trend that went one way and there's been some nice profit-taking going on," said Jeff Gladstein, global head of FX trading at AIG Financial Products in Wilton, Connecticut.

Investors had sold the Japanese currency after the Group of Seven rich nations did not address yen weakness at their meeting in Washington over the weekend. That encouraged investors to put on carry trades, in which investors borrow funds in low-yielding currencies such as the yen to invest in higher-returning assets like sterling.

"At this point, we're just biding some time here," said Gladstein, before traders resume selling the yen.

Sterling Soars

Sterling was up 0.9% , and hit its highest point since September 1992. The pound last hit the $2 level just before Britain exited the pre-euro Exchange Rate Mechanism in 1992. Earlier on Tuesday, data showed British consumer prices had accelerated at a 3.1% annual rate in March, the highest level since comparable records began in 1997.

The UK data reinforced expectations for an inflation-busting May interest rate hike in Britain to 5.5% and priced in the possibility of more hikes.

"Sterling's rise to the $2.0 level for the first time since September 1992 is an important landmark in the high-yielding make-up of currency carry trades as well as a key development in the weakness of the U.S. dollar," said Ashraf Laidi, chief FX analyst at CMC Markets in New York, in a research note.

Support for European currencies also came after the release of Germany's ZEW index, which showed sentiment among German investors on the outlook for Europe's largest economy improved more than expected in April.