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The dollar weakened on Tuesday, but pared losses late in the afternoon after dropping to six-week lows against the euro earlier, as traders grew cautious about the results of the US midterm elections.
Traders said the dollar came off lows going into the end of the New York session, with markets covering their short positions built earlier and selling the euro after it failed to sustain gains above $1.2800 versus the dollar.
"With US election results not yet at hand and uncertainty in the market, it is easy to sell the dollar," said Joe Francomano, vice president of foreign exchange at Erste Bank in New York.
In late afternoon trading, the euro was up 0.4 percent at $1.2771, after touching a peak of $1.2819, the highest since September 25. Traders said the euro's earlier surge was further fuelled by stop-loss trades around $1.2780-$1.2800.
Polls indicate the Democrats may grab control of the US House of Representatives for the first time in more than a decade in the elections, although President George W. Bush's Republican Party may have a slight edge in its battle to hold the Senate. A Democrat victory in the Senate, however, is not being ruled out, analysts say.
Although most analysts expect the election outcome to have little sustained impact on the dollar, some argue that Democratic control of the lower house could be negative for the currency as it may lead to a rise in protectionist policies or to political deadlock that could slow reforms. "I can't see much of a dollar reaction to the congressional election," said Shaun Osborne, chief currency strategist, at TD Securities in Toronto.
"Markets would assume that a Democrat input into policy-making would make it harder for the Bush administration to spend. But that's pretty much factored in by the market," he added. The dollar fell 0.5 percent to 117.65 yen, and against the Swiss franc, a traditional safe haven in times of uncertainty, the greenback was down 0.5 percent at 1.2495 francs.
The Australian dollar, up 0.2 percent at US $0.7728, was also in focus ahead of a key interest rate decision by the Reserve Bank of Australia. The RBA later on Tuesday is expected to announce a quarter-point percentage increase in its official cash rate to 6.25 percent. Analysts say should the rate hike fail to materialise, the Aussie dollar can expect a drubbing.
Sterling rose 0.5 percent to $1.9056. The greenback has now erased gains made after a solid US jobs report on Friday, a worrying sign for dollar bulls. The dollar was already under pressure earlier in the session after Bank of Japan Governor Toshihiko Fukui said the central bank would raise interest rates pre-emptively to avoid sharp economic swings.
Fukui's comments played to market concerns that the dollar's interest rate advantage is set to wane as the Federal Reserve keeps rates flat, or cuts them as the US economy slows.

Copyright Reuters, 2006

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