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Dollar smug as market mugs defenceless euro

TOKYO: The dollar slipped against the euro and the Japanese yen on Tuesday in Tokyo in quiet trading ahead of meeting later in the day of the US central bank's policy setting board.

Traders said most investors and traders had taken to the bunkers in case the Federal Reserve meeting resulted in anything other than a widely expected 25 basis point rate hike.

Still, that concern did nothing to alter the recent pattern of broad-based dollar strength and widescale euro weakness.

the euro was trading at $0.9706, up from $0.9693 in New York but down from $0.9782 in Tokyo on Monday.

Against the yen, the dollar stood at 107.25 yen, having firmed to a 3-month high of 107.55 in the US from 106.88 here late on Monday.

Taking advantage of the lull, the euro did manage to clamber off a lifetime low of $0.9665, but the bounce was all too quickly stymied by fresh offers at $0.9720. The latest lurch lower came after EU officials displayed a lack of urgency toward its long fall, so feeding the market's perception that the euro was essentially defenceless.

"It almost feels like we're back in the old ERM when the market was testing the limits of the system," said a dealer at a European bank.

In the early 1990s, diverging inflation and growth trends within Europe encouraged speculative attacks, particularly on the French franc, which ultimately resulted in currency trading ranges within the system being widened dramatically .

"But then the French and others fought tooth and nail for the franc fort'. Now they seem to have a euro-appeasement' policy-anyone's allowed to push it around," the bank dealer added.

ECB President Wim Duisenberg did try and sound a little less accommodative on Monday, warning that a further weakening of the euro could mean increased risk to price stability.

But his effort was undermined by euro-zone finance ministers who could come up with nothing more than a five line statement on the currency repeating the well-worn avowal that fundamentals favoured a higher euro over time.

Interest rate differentials between Europe and the US also have weakened the euro by encouraging investors to short the currency-borrow euros and sell them for dollars, with the interest earned on the dollars more than covering the borrowing cost.

That practice could increase if the Federal Reserve raises US rates by 25 basis points on Wednesday, and perhaps by as much again in March.

Traders said the latest slide in the euro had stirred some speculation the ECB would also raise interest rates at its meeting on Thursday. But most doubted it, arguing that inflation was still subdued and economic growth not yet that strong.

Indeed, when the ECB hiked rates in November, the euro fell as the market feared the increase threatened the recovery.

The euro's travails also came at a time when the dollar was enjoying a rush of confidence in the US economy.

Analysts said this in part reflects a growing conviction that the Fed cannot afford to raise rates aggressively since that risks triggering a meltdown on Wall Street.

This has helped fuel a 3.4 percent rise in the dollar's trade weighted index, which measures it against six other major currencies, this month. On Monday the index broke above last year's peak to reach 105.28, the highest level since it was first compiled in 1990.

Traders said the rally had even been powerful enough to slow hedge-related selling by Japanese exporters, allowing the dollar to threaten some key technical levels against the yen.

In particular 108.00/10 was looming large as a target for dollar bulls. This marks a triple top from September and October last year and a break would be considered very bullish, opening the way to 110.00 and even 112.00. Currency bid prices. All data taken from Reuters with percent change calculated from the daily US close.-Reuters