The dollar Tuesday dropped to its lowest against the yen since June 2005 after U.S. retail sales data provided more evidence an economic slowdown was spreading to the consumer.
The drop in retail sales prompted some investors to reduce risky positions and unwind carry trades, in which they borrow in a low-yielding currency such as the yen to buy high-yielding currencies such as the Australian dollar.
U.S. retail sales fell 0.4 percent last month while markets were expecting no change from November.
Economic "growth is falling off a cliff and inflation is still in the background," said Ron Simpson, director of currency research at Action Economics in Tampa, Florida. "There is a flight to safety with some unwind of carry trades and high yielders getting hurt."
Against the yen, the dollar fell after dropping as low as 106.61, according to Reuters data. The Australian dollar fell versus the dollar, well off the day's high of US$0.9018.
The euro was last little changed against the dollar, though it was off the day's high of $1.4922. Euro/yen fell to a four-month low of 158.54 before recovering some ground.
Andrew Busch, a global foreign exchange strategist with the Bank of Montreal in Chicago said in a note to clients the loss of spending momentum highlights a growing risk that the economy would contract in the first quarter.
To offset that risk, financial markets expect the Federal Reserve to cut benchmark overnight interest rates by at least a half percentage point when its monetary policy committee next meets on Jan. 29-30. Lower rates reduce the attractiveness of dollar-denominated securities and demand for the greenback.
"These are definitely dollar-negative figures especially retail sales," said Omer Esiner, market analyst, Ruesch International in Washington. "The report raises concerns about the health of consumer spending and increases the likelihood that the U.S. may slip into recession. That, in turn, increases the chances of aggressive interest rate cuts."
A separate report showed U.S. producer prices declined unexpectedly by 0.1 percent in December after a sharp drop in fuel prices, government data showed on Tuesday, but core inflation at the producers level rose by 0.2 percent as projected.
The dollar had earlier pared losses against the yen after Citigroup announced smaller-than-expected write-downs, slightly easing concerns about the U.S. economy and boosting investors' risk appetite.
The largest U.S. bank announced write-downs of $18.1 billion in the fourth quarter, slightly below press reports that had suggested write-downs of as much as $20 billion.
The fact that the news was not as bad as some had feared led investors to pare back short dollar positions and move out of the low-yielding, safe-haven yen. However, the reaction was relatively muted and short-lived.
"It's a case of buy the rumor, sell the fact, 18 yards (billion) of losses is a big number but the market is happy to have the bad news out of the way," said Geoff Kendrick, currency strategist at Westpac in London.
"The market is still worried that the Fed is going to cut aggressively ... which will lead to more dollar weakness," he added.
Citigroup is the first big bank this week to report fourth-quarter earnings and the spotlight will now shift to others, including JP Morgan on Wednesday. Investors are looking to see how much the credit crisis is damaging banks' bottom lines and increasing the risk of a recession.