Iraq dominates the currency markets (page 1 of 2)

Euro

The week began with markets focused on the release of the U.N. weapons inspectors report to the Security Council on Baghdad's compliance with demands outlined in a tough council resolution.

Chief inspector Hans Blix told the Security Council that Iraq had provided access to weapons sites only grudgingly and that Iraqi President Saddam Hussein had also failed to fill gaps in information about Iraq's past programmes on weapons of mass destruction.

Market participants saw his remarks as increasing America's determination to take military action to oust Saddam's regime. Euro/dollar tested a 3-year high of 1.0907 before retreating on nervousness about possible intervention after Bundesbank President Ernst Welteke said it would be a worrying sign if the dollar fell too quickly against the euro.

As fears of intervention loomed in the financial markets, euro/dollar failed to get much of a lift after Germany's key Ifo business sentiment indicator rose for the first time in eight months to 87.4 in January. The dollar also received mild support from a smaller-than-expected fall in U.S. consumer confidence in January and a hefty rise in new home sales for December.

Midweek, the euro again tested the $1.0899 level in reaction to President Bush's State of the Union address. The U.S. led war with Iraq seemed to draw closer after President Bush said, "crucial hours may lie ahead" for U.S. troops in the Gulf. Bush made it clear that the U.S. was prepared to act to disarm Iraq with or without U.N. backing.

However, the euro backtracked after fresh comments from Ernst Welteke who said the rapid pace of the euro's rise in value against the dollar would pose a problem for the euro zone economy if it continued.

The greenback also found some reprieve as worries about the U.S. economy were soothed a bit after the Federal Reserve, at the end of its two day monetary policy setting meeting, maintained that the risks to the economy were finely balanced between downturn and inflation.

The Fed kept interest rates unchanged at 1.25 pct. There was a sense of relief as some analysts had thought the Fed might be more pessimistic about the economy and state the balance of risk had again shifted towards weakness.

The Fed's uplifting message and renewed hopes that Washington will not have to go to war alone if it sought to disarm Iraq by force, prompted investors to buy back some dollars. Fears that the U.S. would not have to foot the hefty war bill alone subsided on Thursday, after leaders of eight European nations published a letter of support for Bush in the Wall Street Journal.

The leaders called on the peace camp, implicitly Germany, France and Russia, to rally to the U.S. stand against Iraq. The U.S. unit gained a psychological foothold and the euro fell as low as $1.0733. The dollar's gains unravelled later in the day after advance fourth quarter gross domestic product (GDP) figures indicated tepid growth.

The U.S. economy expanded only 0.7 pct versus the buoyant 4.0 pct leap in the previous quarter. Additionally, a massive fourth quarter loss posted by AOL Time Warner also demoralized Wall Street and the dollar. The Dow Jones Industrial Average closed below 8000 for the first time since October.

Going into the last trading day, data showing the U.S. manufacturing sector expanded in January and signs of strength in U.S. consumer spending, momentarily deviated market's attention from the U.S. - Iraq developments, and helped buoy the dollar to 1.0725 level against the euro.