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The dollar dropped to a two-month low against the euro on Thursday, weakened by soft data on US consumer sentiment and China's announcement that it had a clear plan to diversify its foreign exchange reserves.
The dollar lurched lower after Chinese central bank governor Zhou Xiaochuan said China was "considering lots of instruments" to diversify its $1 trillion of reserves.
"We have long warned against the diversification wave by global central banks in light of the peak in US interest rates and the need to diversify into other currencies and commodities that are boosted by steadying commodity prices," said Ashraf Laidi, chief FX analyst at CMC Markets in New York. China's announcement came in the wake of similar diversification efforts by major central banks such as Russia and Switzerland.
The euro rose to a two-month high against the dollar to $1.2848 before trading back down to $1.2827 by late afternoon, still up 0.6 percent on the day. A US trader from a retail brokerage firm said the pair needs to take out solid resistance at $1.2840 to gain further upside momentum.
The trader also noted that talk of an options barrier at $1.2850 could cap the euro. "We're looking for a grind higher with many likely short-term corrections," the trader said.
The dollar pared gains against the yen to stand at 117.91 yen, flat on the day. The currency pair barely budged despite a report by Japan's Yomiuri newspaper late on Thursday quoting Bank of Japan Governor Toshihiko Fukui as saying that the BoJ will adjust rates gradually. Fukui also said further rate increases would not derail economic recovery.
The greenback earlier came under pressure after the University of Michigan's consumer sentiment survey showed a decline in the headline index and a slight fall in inflation expectations.
"To the extent some in the market have been anticipating a rebound in fourth-quarter US growth, the lower Michigan reading detracts from this and suggests lower energy prices have exerted whatever positive influence they're going to on the US consumer sentiment," said Brian Dolan, director of FX research at Forex.com, in Bedminister, New Jersey.
The dollar was down 0.7 percent against the Swiss franc at 1.2428 francs, weighed down by comments from Swiss National Bank board member Philipp Hildebrand on Thursday saying the central bank could raise interest rates to avoid long-term distortions even without a near-term inflation threat.
Sterling, meanwhile, recovered to trade little changed on the day against the dollar at $1.9050. The British pound had fallen after the Bank of England raised interest rates by 25 basis points to 5.00 percent on Thursday, as expected, but did not provide clues on the outlook for next year.

Copyright Reuters, 2006

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