The dollar weakened broadly on Wednesday as investors contrasted Federal Reserve comments pointing to continued US economic weakness with expectations for further inflation-busting talk from the euro zone.
An ailing sterling fell to record lows against the euro at 80 pence, as falling UK consumer morale and an IMF downgrade to growth stoked debate on how aggressively the Bank of England might cut rates after its policy meeting on Thursday.
The dollar found respite from steep falls versus the euro last week but the rally was cut short after minutes from the Fed's last policy meeting showed some central bankers believed "a prolonged and severe economic downturn could not be ruled out".
Despite data earlier confirming that euro zone economic growth had slowed in the last quarter of 2007, investors were still contrasting a relatively robust euro zone economy with an ailing US - in the grip of a major slowdown. "When the FOMC minutes came out they were a lot more dovish than some people would have expected," UBS currency strategist Geoffrey Yu said from Zurich.
"The market is not too convinced on the euro zone but you are being forced to choose between the less of two evils right now. People are still preferring to chase the euro higher rather than the dollar," he added. The European Central Bank (ECB) is expected to keep rates steady at 4 percent after its policy meeting on Thursday with analysts attention focused more on the post-decision press conference.
"ECB will undoubtedly preach a fire and brimstone sermon on inflation risks," Danske Bank said in a note to clients. The euro was up 0.1 percent at $1.5724, while the dollar fell 0.2 percent to 102.35 yen - reversing earlier gains that took it near a one-month high.
The euro hit a record high of 80 pence early in the European session, before pulling back to 79.86 pence, up 0.1 percent on the day. FOMC minutes released on Tuesday showed the Fed remains concerned about further restrictions on credit availability and ongoing weakness in the US housing market, underscoring market expectations for further Fed rate cuts.
Futures markets see a 56 percent chance of the Fed lowering interest rates by 25 basis points from the current 2.25 percent at a policy meeting in late April, and 44 percent chance of a more aggressive 50 basis points cut.
Investors were also focusing on an upcoming meeting of G7 finance officials in Washington starting on Friday to see whether delegates will show a united front on efforts to quell ongoing problems in credit markets.
A Reuters poll taken on Wednesday shows the Japanese central bank's next rate move will be a rise, but that this would not happen until the first half of 2009. Currency markets also digested reports that Citigroup Inc was close to a sale of leveraged loans and bonds to a group of private equity firms.
People familiar with the situation said on Tuesday that Citigroup, the largest US bank, was close to selling about $12 billion of leveraged loans and bonds to private equity firms including Apollo Group, Blackstone Group LP and TPG.
Citigroup, Apollo, Blackstone and TPG declined to comment. Despite some recent signs of stabilisation, concerns about the fallout from the credit market turmoil were likely to linger ahead of quarterly earnings announcements by US banks later this month, traders said.
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