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The dollar slid again on Monday on worries that central banks might gradually shift their foreign exchange reserves away from the currency. The dollar hit a 2-1/2-month low versus the euro and an 18-month low against sterling on Friday after People's Bank of China Governor Zhou Xiaochuan reiterated that Beijing planned to diversify its $1 trillion in reserves - the world's largest.
Zhou, speaking a day after roiling the markets with similar comments, said that China sought to diversify its assets across different currencies and investments, including emerging markets.
Dealers said that any reserve shifts could help the yen as well as other currencies. In recent weeks, the central banks of Russia, Switzerland and the United Arab Emirates have expressed interest in buying yen or have already shifted funds into the currency. "Talk about China's foreign reserve diversification is likely to keep supporting the yen," said Hideki Hayashi, a global strategist at Shinko Securities.
Japanese investors have also been trimming the proportion of dollars in their investment trusts in favour of sterling, euro, and the Australian and New Zealand dollars, said Mitsuru Sahara, senior trader at Bank of Tokyo-Mitsubishi UFJ Bank.
The euro rose to $1.2875 from around $1.2840 in late US trade on Friday, when the single currency climbed to around $1.2900 - the highest since August 21.
The dollar eased to 117.25 yen from around 117.60 yen in the face of selling by a large US securities firm and a big Japanese bank, traders said. Sterling was at $1.9140, climbing towards an 18-month high of $1.9180 hit on Friday. Traders said the dollar was coming under added selling pressure against currencies with prospects for further rises in interest rates, particularly the euro.
Market forecasts have strengthened for the European Central Bank to keep raising rates in 2007, following a widely expected hike in December. European currencies will likely be favoured over the higher-yielding Australian dollar as the Reserve Bank of Australia is expected to keep rates on hold for now after already boosting by 75 basis points this year, traders said.
Swiss National Bank Chairman Jean-Pierre Roth told that a Swiss newspaper on Sunday that further rate rises were in the pipeline to fight inflation due to a weak Swiss franc. The US currency slipped to 1.2370 francs from a high around 1.2400 francs. But it may be premature to conclude the dollar is at the start of a downtrend, as the currency could still get a lift if upcoming economic data offers evidence of a soft landing for the US economy.
"We aren't sure if we can start betting on a weak dollar trend. The euro is clearly a buy, but we don't yet have a clear reason to sell the dollar," said Yuichiro Harada, a senior trader at Mizuho Corporate Bank. Despite talk of diversification as well as expectations the Bank of Japan will raise rates by March, a wide rate gap should limit the yen's gains, said Sahara at Bank of Tokyo-Mitsubishi. For more clues about the health of Japan's economy and the outlook for rates, traders were looking to third-quarter gross domestic product data due on Tuesday.

Copyright Reuters, 2006

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