Dollar slides as inflation fears boost euro

New Zealand currency trades lower as top official predicts rate cuts

By Deborah Levine and Sarah Turner
MarketWatch

NEW YORK (MarketWatch) — The U.S. dollar extended losses against the euro on Wednesday as oil prices spiked above $101 a barrel, raising the risk of inflation and expectations that the European Central Bank will be quicker to react than the Federal Reserve.

“The market is looking for the ECB to move well ahead of the Fed,” said Ron Leven, senior currency strategist at Morgan Stanley. “For political purposes, they are sounding hawkish.”

The dollar index (DXY 76.46, -0.21, -0.27%) , which measures the U.S. unit against six major currencies, fell to 76.685, down from 77.049 late Tuesday.

The euro (EURUSD 1.3965, 0.0000, 0.0000%) rose to $1.3861, erasing losses in the Asian session and up from $1.3777 in North American trading Tuesday.

The British pound (GBPUSD 1.6277, +0.0004, +0.0246%) rose to $1.6329, up from $1.6260. See real-time currency quotes and tools.

The euro’s recovery came after data showed an unexpectedly strong surge in euro-zone producer prices during January. See more on euro zone PPI.

“Today’s larger-than-expected rise in PPI clearly ratchets up interest-rate hike expectations,” said Boris Schlossberg, director of currency research at GFT.

The European Central Bank meets on Thursday and is fully expected to leave its key lending rate unchanged at a record-low 1%. Some expect policy makers to take steps toward winding down its emergency funding programs, setting the stage for an interest-rate hike in coming months.

The ECB is expected to raise interest rates sooner in the year than other central banks, said Dan Cook, chief executive of IG Markets.

“If oil prices stay dramatically higher for another three or four months, then we might see a hike,” he said.

Otherwise, the ECB will probably wait longer than most in the market seem to be anticipating as problems with sovereign debt in the region have hardly gone away, he said.

“It’s just a matter of time before we see those things come back into the headlines and the economy isn’t strong enough,” Cook said.

He expects the euro to run into resistance if it gets to $1.40, but sees technical support around $1.32 if it turns down.

Flight to safety

The dollar found some support on Tuesday as Middle East jitters sent oil prices sharply higher, weighed on equity markets and boosting Treasury bonds. It was the nature of the news reports that once again supported the dollar, analysts said. Read about dollar’s gains Tuesday.

For the last few weeks, the uncertainty brought about by protests and uprisings in parts of the Middle East has benefited other safe-haven currencies — namely, the Japanese yen and the Swiss franc — to a greater degree.

When traders get a chance to weigh the flight-to-safety flows against interest-rate expectations, the dollar shows its weaknesses.

Crude-oil futures topped $102 a barrel on Wednesday, weighing on stocks and the dollar. See story on crude oil.

The greenback fell 0.4% against the Swiss franc (USDSWF 0.9315, +0.0002, +0.0215%) .

The dollar also gave up slight earlier gains to buy 81.90 Japanese yen (USDYEN 82.4000, -0.0100, -0.0121%) off from ¥81.93 late Tuesday.

A private report on U.S. employment growth last month topped expectations, but this failed to blunt selling in the dollar. The report, based on a sampling of ADP payrolls data, did little to change economists’ forecasts for the government’s more important, broader nonfarm-payrolls report due out on Friday. Read more on ADP.

Neither did observations in the Fed’s Beige Book, released Wednesday afternoon, saying companies were beginning to raise prices. Read story on Beige Book.

“The Fed’s Beige Book did nothing to dispel the notion that the U. .recovery is progressing, but at a meandering pace, with few nascent inflation concerns,” said David Watt, senior fixed income and currency strategist at RBC Capital Markets.

New Zealand and Australia

During Asian trading Wednesday, the New Zealand dollar came under heavy pressure after Prime Minister John Key said that he expects the Reserve Bank of New Zealand will probably cut interest rates. Read more on New Zealand rates.

The New Zealand dollar (NZDUSD 0.7398, -0.0008, -0.1080%) fell 0.5% to buy 74.39 U.S. cents..

The Australian dollar (AUDNZD 1.3680, +0.0006, +0.0439%) rose 0.8% to NZ$1.3684 after data showing Australia’s economy expended in the fourth quarter of 2010. Read more on Australian GDP.

It initially weakened against the greenback, but turned up during U.S. trading (AUDUSD 1.0130, -0.0014, -0.1380%) by 0.2% to U.S. $1.0172.

Deborah Levine is a MarketWatch reporter, based in New York. Sarah Turner in Sydney and William L. Watts in London contributed to this report.

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