Dollar continues to strengthen as US interest rate cut seems likely

The dollar continued to strengthen yesterday, breaking through a new one-month high, as markets set their sights on the US interest rate cut likely to be delivered tomorrow, writes Una McCaffrey

The US currency surged as investors were increasingly persuaded that the Federal Reserve would settle for a 25-point cut in interest rates rather than a more aggressive 50-point reduction.

From $1.1606 against the euro in New York at the end of last week, the dollar climbed to $1.1508 yesterday, before dropping back slightly in later trade to settle at $1.1546.

A week previously, the single currency had risen to $1.1931, matching its lifetime highs, as investors priced in a half-point rate cut.

The Fed starts a regular two-day meeting today and will issue a statement on Wednesday.

Ulster Bank financial markets economist Mr Niall Dunne said the euro was "taking a breather" as markets sensed the mystery had been taken out of the Fed's decision.

He predicted that market attention would now focus on the tenor of the US monetary authority's statement rather than any move on interest rates.

"If the Fed remains hawkish on recovery and concerned about deflation, the current strength of the dollar could prove short-lived at best. Yet, if they talk up recovery, the bond market could collapse," said Mr Dunne.

Over the past several months, a widening yield gap of euro-zone bonds over US Treasuries has boosted global investors' demand for euro-zone assets and supported the single currency at the dollar's expense.

But the euro is now failing to garner support from that rate outlook as investors start to focus more squarely on the relatively lacklustre euro-zone economy.

"The statement is almost more important than the decision," agreed Mr Kamal Sharma, currencies strategist at Commerzbank.

"A 25 basis point cut and a neutral bias is probably the best outcome for the dollar, but any mention of falling prices or deflation and we'll see a softer dollar," he said.

Mr Dunne said any dip into levels around $1.14 could be beneficial for those seeking to offload dollars they have been holding over recent weeks.

He believes a return to the $1.20 range is likely when the dust settles over the US monetary decision.

Others disagree, however, with Citibank noting in research issued yesterday that it has adopted an eventual target of $1.10 for the euro against the dollar.

"The euro is down across the board; against sterling, yen and dollar. I think it's more of a euro story than a dollar story," said Mr Tim Mazanec, senior currency strategist with Investors Bank & Trust in Boston.

"The euro seems very vulnerable to a move lower against the dollar, with support between $1.1530 and $1.1520. Below that, I don't see much \ before $1.1430," Mr Mazanec said. - (Additional reporting, Financial Times Service, Reuters)