Appeal of the dollar drops

The dollar declined against 12 of the 16 most-actively traded currencies before U.S. reports today that may show slowing manufacturing growth, backing the case for a Federal Reserve interest-rate cut next month.

The dollar fell the most versus the British pound and the Australian dollar on signs the rate advantage in the U.S. will narrow, diminishing the appeal of dollar assets. Investors are very concerned that the U.S. economy may slow further there is a pronounced bias still for dollar weakness.

The U.S. currency tumbled to a record low on Nov. 7 against a basket of major currencies, including the euro and the yen, after Cheng Siwei, vice chairman of China's National People's Congress, said the Asian nation will invest in stronger currencies when diversifying its $1.43 trillion foreign reserves. Interest-rate futures show a 72 percent chance the Fed will lower the target rate for overnight lending between banks a quarter-percentage point to 4.25 percent on Dec. 11.

The British pound was the only high yielding currency pair to not rally against the US dollar yesterday. Fundamental and technical factors are calling for major losses in the British pound. To the surprise of the market, the Bank of England’s Quarterly Inflation report revealed a central bank that is still struggling to balance weaker growth with stronger inflation.

They revised their 2008 GDP forecasts from 2.7 percent down to 2.4 percent which is a big change and warned that they expect the inflation rate to rise above their two percent target next year before falling back below it in 2009. The uncertainties surrounding inflation and growth are both increasing leading Bank of England Governor King to forecast more difficult times ahead.

Over the past few weeks, UK economic data has revealed cracks in the economy prompting some traders to call for an interest rates cut by the Bank of England in the first quarter of next year. Meanwhile the labour market remains tight with the unemployment rate at a 2.5 year low which suggests that retail sales tomorrow could surprise to the upside.

The Euro is struggling to stay afloat despite stronger economic data. GDP growth in the third quarter rose to 0.7 percent, which was slightly higher than the market’s expectations. Growth in Germany and France both improved highlighting the region’s ability to handle a strong currency.

According to the comments from ECB officials yesterday, the inflation risks are still skewed to upside due to high food and energy prices. ECB member Hurley also warned that the risk is for further dollar weakness versus the Euro.

However stronger economic data and hawkish comments have not helped the Euro hold onto its gains in the US trading session. The single currency sold off from its intraday high of 1.4721 down to 1.4637. Eurozone consumer prices are due for release today.

The euro gained against the dollar for a third day on speculation the ECB will need to raise interest rates to keep inflation under control, narrowing the gap with the U.S. The annualized rate of inflation is expected to remain above the ECB’s 2 percent target well into the New Year.

The best performing commodity currency was the New Zealand dollar which staged a strong rally on the back of a sharp rise in producer prices last quarter. Retail sales were weaker but not very market moving.

The Australian dollar also gained ground but the rise was limited because of consumer sentiment which fell to an 11 month low.

Canadian leading indicators and motor vehicle sales were also weaker than expected causing the Canadian dollar to be the only one of the three currencies to under perform the US dollar. Commodity prices are higher today but their limelight was stolen by the broad volatility in the equity markets.

Morning Market Rates:
(Indication prices only, they are not offer rates)

GBP/USD: 2.0512
GBP/EUR: 1.3965
GBP/AUD: 2.2795
GBP/CHF: 2.3017
GBP/ZAR: 13.5110
USD/JPY: 111.28
USD/ZAR: 6.5562
EUR/USD: 1.4625
EUR/ZAR: 9.6575
GBP/NZD: 2.6835
GBP/AED: 7.5505
GBP/CYP: 0.8075
GBP/CAD: 1.9735
GBP/INR: 79.02