The Australian dollar steadied on Monday, paring losses made after China's central bank raised rates at the weekend in a move seen largely priced in, while other major currency pairs held tight ranges in quiet trade. The euro inched higher against the dollar in low volume trading with London markets shut on Monday and Tuesday and liquidity expected to be at a premium until the New Year.
While the market had been expecting Beijing to tighten further, the timing was a surprise as there had been doubts whether it would raise rates before the end of the year. Saturday's move by the Chinese central bank to raise interest rates was the second in just over two months, underscoring its desire to dampen domestic demand and get price pressures under control.
Australia has benefited from strong Chinese demand for iron ore and other commodities. "There was a knee-jerk sell-off in the Aussie but investors knew this China move was coming eventually. Providing the Chinese data holds up in 2011, the Aussie should stay supported," said Geoffrey Yu, currency strategist at UBS. The news knocked the Australian dollar as low as $0.9987 in Asia but it recouped its losses to trade flat in European trade at $1.0035, not far from a six-week high of $1.0067 hit last Thursday.
"The pace of (China) rate hikes has so far been relatively aggressive. Nonetheless, we still expect only three rate hikes next year and they will probably be frontloaded in H1 2011. We expect the PBoC to be on hold through most of H2 2011 as inflation again starts to ease," said analysts at Danske Bank in a note to clients.
The euro was up around 0.3 percent versus the dollar at $1.3158, holding above a three-week low of $1.3055 hit last week, but clouded by worries over debt refinancing requirements of countries such as Spain and Portugal into the new year. Markets have put Spain's debt issuance plans under particular scrutiny since Ireland applied for a bailout, forcing up the Spanish government's borrowing costs.
Technical analysts said the outlook was brighter for the single currency while it held above its 200-day moving average at $1.3087. The dollar slipped slightly against the Japanese yen, touching a three-week low of 82.66 yen. It was last at 82.82, close to unchanged for the day.
Although stuck in a range of 82.50 to 84.50 yen, the dollar has been ticking down in the past couple of weeks as holders of long positions have given up hopes of pushing it beyond 85 yen. "A sharp rise in US bond yields earlier this month has prompted many traders to bet on a rise in the dollar. But as the dollar was unable to extend gains, traders have been cutting long positions," said Katsunori Kitakura, chief dealer at Chuo Mitsui Trust Bank.
The dollar/yen rate has had a high correlation with US bond yields, particularly for two-year notes, but the relationship has weakened this month. Last week it broke down as the two-year US yield rose more than 5 basis points while the dollar fell 1 yen. An auction of $35 billion in two-year US Treasuries later in the day will be closely watched for clues on where US bond yields may be headed after a volatile month in the bond market.
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