Testing week for the US dollar

Euro

The dollar tumbled across the board, driven lower more by technical than fundamental factors, with concerns about the dollar's long-term structural problems still weighing on sentiment.

The breakout of recent ranges in the euro, sterling, Swiss franc, Canadian dollar and Australian dollar triggered previously placed "stop-loss" orders and options-related trades that drove the dollar down to its lowest levels in about two months against the euro.

Technical weakness, concerns over the U.S. external deficits and their funding, constant talk of central bank reserve diversification and Middle East tensions and instability, were all cited as reasons to be wary of holding dollars.
The surge in oil prices with U.S. crude futures hitting $55.65 a barrel also weighed on the struggling dollar.

Meanwhile, concerns about the U.S. current account deficit were once again underscored this week when billionaire Warren Buffet said in his annual letter to shareholders that U.S. trade policy would "put unremitting pressure on the dollar for many years to come".

The dollar slipped in a volatile session on the last trading day after data showed the U.S. trade deficit widened in January to its second biggest on record despite the greenback's three-year decline.

The deficit widened in January to $58.3 billion, according to the Commerce department, from a downwardly revised $55.7 billion in December. Economists had forecast a gap of $56.5 billion. Exports rose to a record $100.8 billion, however, American consumers' insatiable appetite to consume pushed up imports at a faster pace to $159.1 billion, also a record.

The trade numbers were a reminder that around $2 billion a day in foreign capital is needed to fund the gap and limit further dollar weakness. Meanwhile India's central bank governor said diversification of its foreign currency holdings was being discussed within the bank and was a subject of ongoing debate among all central bankers.

Adding to dollar weakness was comments from Federal Reserve Chairman Alan Greenspan, speaking to the Council of Foreign Relations, repeated that foreign investors may at some point decide they are holding too many dollar-denominated assets.

European investors will scrutinise U.S. current account and foreign capital inflows data in the coming week to gauge the health of the dollar, especially after recent talk of central banks diversifying out of dollars.

Range for this week: $1.3250-$1.3550

Yen

The dollar's losses versus the yen were reined in as markets continued to digest comments by Bank of Japan Governor Toshihiko Fukui, who said that Japan had no intention of diversifying its foreign exchange reserves, the world's largest.

Moves by central banks in some Asian countries to diversify away from the dollar and speculation that more could do the same have contributed to the dollar's decline.

Fukui's comments came in the wake of a bank for International Settlements' quarterly report that showed the share of dollars in Asian banks' foreign currency holdings fell to 67 percent in September 2004 from 81 percent in 2001.

Japan's Prime Minister Junichiro Koizumi meanwhile, rattled markets by saying diversification of foreign exchange reserves was "necessary", reviving fears of Asian central banks cutting their giant dollar reserves. Japan's Finance Ministry quickly clarified that it had no intention of reducing the dollars in its $840.6 billion of reserves.

Technical selling that continued into the second day saw the dollar breach key levels that spurred even more selling, taking it to a one-month trough versus the yen. The dollar fell to around 103.62 yen, its lowest level since Feb 4

Range for this week: $103.00-$106.00

Sterling

Sterling rose towards 2005 highs against the dollar but slipped against the euro as volatile moves in the euro/dollar pair took centre stage ahead of the U.K. interest rate decision.

Market speculation is simmering that the Bank of England will raise interest rates later this year but policymakers left interest rates steady at 4.75 percent for the seventh month in a row this week.

Sterling has been riding high in recent weeks on growing expectations of a rate hike later this year and as relatively high UK interest rates lured investors seeking a higher yield. Sterling marched after worse than expected trade data from the United States, showed trade gap widened to $58.3 billion in January, sparking a sharp slide in the dollar.

In the coming week, markets look forward to a speech by the BoE's Rachel Lomax on Saturday and critical UK data due next week includes retail sales and labour market figures.

Range for this week: $1.9150-$1.9450