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The dollar hit one-year lows against European currencies on Wednesday as investors speculated about a pause in US rate rises, while talk of higher Japanese interest rates boosted the yen.
The US Federal Reserve is widely expected to raise overnight rates by 25 basis points for the 16th straight time at its meeting on Wednesday, taking the key rate to 5 percent. But markets are nervous that the central bank will indicate a pause in its two-year tightening campaign.
The dollar was also under pressure ahead of the release of a US Treasury currency report, which markets speculate may name China as a currency manipulator.
The yen hit an 8-month peak against the dollar and 6-week high against the euro and short-term Japanese government bond yields hit 7-year highs on speculation that the Bank of Japan could start raising overnight rates from near-zero levels as soon as June.
Sources close to the Bank of Japan said on Wednesday the BOJ was likely to use stronger wording to describe the improving economic outlook in its monthly report next week.
"There is a lot of nervousness and erratic moves in the markets," said Adam Baines, currency strategist at Citigroup. "The Fed meeting tonight will be the next concrete thing for the markets to focus on." By 1145 GMT, the euro was up a quarter percent on the day at $1.2781, off an earlier one-year high of $1.2804.
The euro ticked down slightly after European Central Bank Governing Council member Axel Weber told Bloomberg interest rates must rise by at least 25 basis points in the eurozone.
The dollar was down more than half a percent against the yen at an 8-month low of 110.32, and the euro dropped a third of a percent against the yen to a 6-week low of 141.14.
After the initial yen rally, Japanese Finance Minister Sadakazu Tanigaki said he opposed sharp moves in currency rates and that a G7 statement on global imbalances last month did not allude to a need for the dollar to fall.
The New Zealand dollar fell 1.5 percent on the day to 22-month lows against the yen and dropped 1 percent on the dollar as investors unwound carry trades, which involve borrowing low-yielding currencies and buying high-yielding assets.
Sterling fell against the dollar and euro after the Bank of England lowered its growth profile in its quarterly inflation report. Sterling earlier rose after data showing the British March trade deficit narrowed sharply.

Copyright Reuters, 2006

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