Hurricane Rita to drive markets

Euro

The euro commenced the week on a weak tone after an inconclusive German election threatened a prolonged period of uncertainty and further delayed the implementation of structural reforms in Europe's biggest economy.

Meanwhile, European central bank President Jean-Claude Trichet said that eurozone interest rates were at historically low levels and that structural reforms were needed in Europe.

The dollar further strengthened against the euro after the Federal Reserve raised interest rates by a quarter of a percentage point to 3.75 percent and its accompanying statement appeared to leave the door open to more rate increases ahead.

In its statement, the policy setting Federal Open Market Committee wrote that: "With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured".

Midweek, the dollar traded nervously with markets reluctant to take fresh positions on concerns that Hurricane Rita could turn into a major storm and pummel oil facilities in the Gulf of Mexico already battered by hurricane Katrina in late August.

The greenback sagged testing $1.2270 levels versus the euro, after a rally in response to the latest U.S. interest rate hike fizzled and as attention shifted to the growing threat Hurricane Rita posed.

Recognising the risk that Hurricane Rita poses, oil companies shut down refineries in Texas. A squeeze in supply of products such as gasoline, especially if sustained, could force up energy costs and slow U.S. economic growth in the long term.

However, the last trading session witnessed the greenback rally after Hurricane Rita was downgraded to a Category 3 storm and also on news that a Group of Seven wealthy nations statement would not as yet contain any call for further yuan revaluation moves by China.

The euro tumbled to a two-month low of $1.2037 after China said it would widen the daily trading band for its currency against units other than the dollar from 1.5 percent to 3 percent.

In the week ahead, the path taken by Hurricane Rita is set to drive the markets, with investors also keenly awaiting the speech by Fed Chairman Alan Greenspan for hints on whether the Fed might slow the monetary tightening campaign.

Greenspan speaks via satellite to the American Bankers Association Annual Convention on Monday and to the National Association for Business Economics on Tuesday.

Data scheduled includes U.S. consumer confidence for September and the Chicago manufacturing index, while durable goods orders and U.S. personal income and spending data will also attract attention.

Last week's range: $1.2037-$1.2270

Yen

The dollar held firm against the yen after the Fed raised interest rates and left the door open for further rate hikes. The dollar tested 112.03 yen after the hike, however its advances were capped by jitters about Hurricane Rita and by Japanese exporters' selling of the U.S. currency above 112 yen.

The last session of the week witnessed the greenback touch 112.50 levels against its Japanese counterpart after China said it would now let the yuan range as much as 3 percent a day against non-dollar currencies such as the yen and euro instead of 1.5 percent.

The Chinese central bank made no change to the yuan's theoretically permitted trading range against the dollar of 0.3 percent a day, set on July 21.

In Washington, the Chinese revaluation story will likely feature at the annual meeting of the World Bank and International Monetary Fund over the weekend.

Range for this week: Y110.50-Y113.50

Sterling

Sterling hit a 3-week low against the dollar at the start of the week after comments from a Bank of England policy maker fanned talks of a cut in interest rates later this year.

BoE MPC member Stephen Nickell said there was a "serious risk" the British economy would not recover as strongly as the bank had anticipated. Midweek, sterling regained composure, as markets feared the new hurricane could wreck as much havoc in the United States as Katrina. The pound was also boosted after minutes from this month's BoE MPC meeting revealed a unanimous vote to hold rates steady.

However on Friday, sterling dipped to $1.7750, its lowest level in seven weeks against the dollar, pushed down by a rebound in the U.S. unit. Meanwhile, the Confederation of British industry said that its monthly manufacturing order books balance improved to -27 in September from -29 in August but still showed sharply falling orders.

Economists had forecast a reading of -25. The data turned the focus back to a possible cut in UK interest rates from the current 4.50 percent. Merger activity was also cited as a possible reason for the decline, after shares in Spanish Oil Company Repsol climbed 3 percent on talks that UK rival BP would make a bid.

However, overall sentiment towards sterling remained weak as investors waited for signs as to whether more interest rate cuts will be required.

Range for this week: $1.7600-$1.7900