Dollar Snaps Two-Day Drop on Rising Bets for Fed Rate Increase

By Bo Nielsen and Ye Xie

May 22 (Bloomberg) -- The dollar snapped two days of declines against the euro, rallying from the lowest level in a month, as traders added to bets the Federal Reserve will raise interest rates by year-end and oil retreated.

The U.S. currency also gained versus the yen after minutes of the Fed's April meeting yesterday showed most policy makers viewed the cut in the target rate to 2 percent as ``a close call,'' indicating the central bank has gone on hold to stem inflation. The New Zealand dollar rose against all of the major currencies after tax cuts reduced the need to lower rates.

``The Fed is telling us to not think in terms of easing,'' said Alan Ruskin, head of international currency strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut. ``That is the most important feature behind the dollar comeback today.''

The U.S. currency strengthened to $1.5710 per euro as of 12:18 p.m. in New York, from $1.5795 in New York yesterday. It earlier touched $1.5814, the lowest level since April 24. The dollar rose to 104.03 yen, from 103.05 yen. The euro traded at 163.43 yen, up from 162.76 yen.

The dollar extended its gains as the price of crude oil fell to $131.85 after surpassing $135 earlier. A decline in the price of oil can lighten the financial burden on consumers.

U.S. house prices fell less than expected in the first quarter. The Office of Federal Housing Enterprise Oversight said its house price purchase index declined 0.2 percent, after rising 0.3 percent the previous quarter. The median forecast in a Bloomberg News survey of 13 economists was for a drop of 1.3 percent.

Kiwi Climbs

The New Zealand dollar rose after Finance Minister Michael Cullen cut taxes, easing pressure on the central bank to lower interest rates to support the economy. The kiwi, as it is known, climbed to 78.96 U.S. cents, the highest level since May 7, before trading at 78.46 cents, from 77.70 yesterday.

The Australian dollar yesterday touched the highest since being allowed to trade freely in 1983 as investors sought the nation's higher-yielding debt. The currency, which climbed to as high as 96.54 U.S. cents yesterday, was at 95.51 cents today, from 96.25. The Aussie has risen about 10 percent this year, the second-biggest gain among the 16 most-traded currencies.

The Aussie will climb to equal value with the U.S. currency for the first time since 1982 as the central bank considers raising interest rates, say banks that include RBC Capital Markets Inc. and ABN Amro Holding NV.

Interest-Rate Bets

Futures on the Chicago Board of Trade show traders see a 92 percent likelihood the Fed will keep its target rate for overnight lending between banks at 2 percent on June 25, up from odds of 88 percent yesterday. Traders also see a 32 percent probability the Fed will lift the rate in September to 2.25 percent, up from a 21 percent chance yesterday.

``The Fed has a more balanced view on inflation and growth,'' said Matthew Strauss, a senior currency strategist at RBC Capital Markets in Toronto, a unit of Canada's biggest bank by assets. The dollar decline has ``lost momentum.''

The dollar has fallen 2 percent against the euro since May 8, after European Central Bank President Jean-Claude Trichet said inflation remains the bank's top priority. That signaled policy makers won't cut the 4 percent benchmark interest rate soon.

The dollar advanced to $1.9786 against the British pound, from $1.9732, and was at 1.0324 versus the Swiss franc, from 1.0250.

The Dollar Index traded on ICE futures in New York, which tracks the dollar against currencies of six trading partners, rose to 72.231, from 71.938 yesterday.

Downgraded Estimate

Gains for the dollar may be limited as the market starts to focus on the Fed's downgrade of its 2008 economic growth estimate, which accompanied the minutes yesterday, wrote Derek Halpenny, head of currency research at Bank of Tokyo-Mitsubishi in London, in a note to clients today.

The central bank cut its growth projections to a range of 0.3 percent to 1.2 percent from its January forecast of 1.3 percent to 2 percent. The Fed's interest-rate reductions this year, a total of 2.25 percentage points, were the most aggressive in almost two decades.

``We expect the dollar to remain under selling pressure as market participants' optimism over a notable upturn in economic activity gradually fades,'' Halpenny wrote.

The euro climbed versus the dollar yesterday after German business confidence unexpectedly rose, bolstering speculation the ECB won't cut interest rates. Germany is the biggest economy in the euro region.

Charts

The European single currency may rise to $1.5850 against the dollar in one week, based on charts used to predict price movements, said Masashi Hashimoto, a senior currency analyst at Bank of Tokyo-Mitsubishi UFJ Ltd.

The currency has held above so-called support at the five- and 21-day moving averages of $1.5663 and $1.5553, respectively, signaling further gains in the near term, Tokyo-based Hashimoto said. Support is where buyers are expected to outweigh sellers.

Buoyed by gains in the Standard & Poor's 500 Index, the yen fell 2.2 percent against the New Zealand dollar and 1.8 percent against the South African rand. The two currencies are popular in the so-called carry trade in which investors borrow money cheaply to invest in assets where rates are higher.

The Japanese borrowing cost of 0.5 percent compares with 11.5 percent in South Africa and 8.25 percent in New Zealand. The allure of the trade falls when currency volatility rises as it jeopardizes returns on the interest rate spread. The S&P rose 0.1 percent after two days of decline.