Weaker dollar spurs interest rate speculation

The US dollar weakened significantly this week after new data showed that manufacturing contracted in November, raising the chances that the US Federal Reserve will cut interest rates. The recent declines began when several central banks, including in China, began talking about diversifying their currency reserves away from the dollar. Investors began to back away from risky investments such as carry trades, which had been supporting the greenback.

During the week the dollar dropped 0.6 percent against the Japanese yen to ¥115.23, while it fell 1.8 percent versus the euro to $1.3323 and was 2.2 percent lower against sterling. Even absent any real data other than an increase in house prices in the UK, sterling also added 0.7 percent in relation to the euro, to £0.6725.

A batch of positive economic data in the Eurozone raised the chances that the European Central Bank will raise interest rates to 3.5 percent when they meet next Thursday. New figures released Thursday had Eurozone inflation at 1.8 percent, only 0.2 percent below the top of the ECB’s target range. Besides its gains versus the US dollar, the euro was also 1.2 percent higher versus the yen during the week, to ¥153.52. The yen was hurt by a downward revision of economic growth in fiscal 2005-2006 from 3.3 percent to 2.4 percent.

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