War fears weaken the US dollar

Euro

The week commenced with the release of the Institute for Supply and Management's manufacturing data which reported U.S. manufacturing expanded for the third straight month in January, with the main manufacturing business conditions index coming in at 53.9 from a revised 55.2 in December.

The dollar enjoyed a short-lived boost on the data but soon slipped to trade lower against most currencies. The dollar fell sharply as the market worried about war, a day before the United States was to present evidence against Iraq to the United Nations.

Speculation that U.S. Secretary of State Colin Powell's comments could bring the United States and its allies closer to war with Iraq unnerved markets, even though U.S. President George Bush announced a week ago that Powell would make such a report.

Gold prices rose to levels not seen in more than six years as investors continued to seek safe-haven investments and oil prices rose more than 2 percent. U.S. stock prices, already burdened by news insurance giant American International Group would take a big charge, also succumbed to war fears.

Midweek, the greenback soared as the United States made what many traders believed was a strong case against Iraq. But the dollar pared gains when it became clear that other members of the UN Security Council remained wary of tougher action. The dollar, which has sunk to its lowest level in nearly four years against the euro, rose sharply on views Powell's testimony would rally support around the U.S. cause.

But the dollar soon drifted lower as other veto-wielding members of the Security Council called for more time for weapons inspectors to do their work. The euro gains were limited by talk of selling by mostly European Central banks in the $1.0855-65 area. Data released painted a grim picture of Germany's economy, with manufacturing orders falling to 4.1 percent in December, the biggest drop in seven years.

Meanwhile, the European Central Bank did what the markets expected and left its key interest rate unchanged at 2.75 percent at its policy board meeting.

The dollar received a fleeting boost on the last trading session against the euro, on euphoria over a constructive U.S. employment report, but the gains quickly gave way to the fears of war and an elevated terror threat.

Economic concerns and dollar selling were temporarily allayed by news that the U.S. economy added 143,000 jobs in January, the fastest rate in more than two years. The jobless rate fell to 5.7 percent from 6.0 percent. However, a closer look at the data revealed that they may have been distorted by temporary factors, prompting traders to snatch away the dollar's hard-fought gains.

The euro reversed its course to trade near $1.0810, well above its post-jobs-data spike lower to $1.0725 levels. Financial markets will take their lead next week from monetary policy testimony by U.S. Federal Reserve Chairman Alan Greenspan, with geopolitical tensions and the prospect of war in Iraq at the heart of the economic agenda. In the eurozone, industrial output data from the region's three largest economies should provide focus in a data thin week.

Range for the week: $ 1.0600 - $1.1100

Japanese Yen

The dollar spiked to 120.90 levels against the yen at the start of the week after Japanese news agency said Prime Minister Junichiro Koizumi was considering appointing a supporter of inflation targeting, as Bank of Japan Governor.

Kyodo cited ruling Liberal Democratic Party sources as saying Koizumi had agreed that Nakahara, a former BoJ board member, was the best choice to replace BoJ Governor Masaru Hayami, whose term expires in March. But Koizumi denied the report, saying the decision was still a 'blank sheet of paper'.

Koizumi later said he might select the new governor around February 20.Yen's gains, have been capped after Japan's revelation late last week that it had intervened discretely in January, buying about $6 billion in dollars for yen. Japanese Finance Minister Masajuro Shiokawa said that the intervention was a warning measure.

The markets also took heed of comments by Japan's vice finance minister for international affairs, Zembei Mizoguchi, who said massive intervention on foreign exchange was possible if the market moved rapidly.

Markets were also keeping an eye on North Korean developments, noting Japan had expressed concern about escalating tensions over the communist state's nuclear ambitions. North Korea said that a surprise U.S. attack on its nuclear reactor would spark 'total war'.

While the yen showed no strong reaction, traders were watching out for any signs of action by Japanese authorities after a senior Finance ministry official declined to comment on rumours of yen selling this week. The country's financial sector has stagnated for over decade.

As Japan is heavily dependent on exports, an overly strong yen is undesirable to policy makers, as it erodes the competitiveness of Japanese exports overseas and eats into profits when translated into yen from foreign currency.

Range for the week: 119.00 -124.00

Sterling

Sterling fell versus the dollar and the euro, after the Bank of England's Monetary Policy Committee (MPC) surprised markets with a 25 basis point cut in interest rates to 3.75 pct. Analysts had forecast the MPC to hold its key rate steady for the 15th month running, for fear of further stimulating a booming housing market.

But the MPC was under pressure to ease amid manufacturing doldrums and job losses. The surprise rate cut was likely to force investors to sell UK assets, mostly stocks, on fear that Britain's economic prospects are increasingly wobbly, hurting the pound in the process.

Economic uncertainty has gradually crept up in Britain after a trickle of weak data signalled cracks in its recently strong performance, undermining confidence. Much of sterling's near-term performance will depend on whether the BOE remains more aggressive than the ECB in future monetary easing, determining which currency will benefit from a more favourable yield.

Range for the week: $ 1.6200 - $ 1.6700.