Dollar rallies

The dollar rose sharply on Thursday, recouping the prior session's losses on the view that the Federal Reserve may continue holding interest rates steady for some time to come. The Fed left borrowing costs at 5.25 percent on Wednesday but dropped language used in earlier policy statements that signalled it was more inclined to choke off inflation by tightening credit than to promote growth by cutting rates.
That shift pushed the greenback to a two-year low against the euro, as markets took that to mean a rate cut may be near. But on Thursday, investors re-evaluated the statement. Analysts emphasised that the Fed also reiterated that it was keeping a close eye on inflation, a stance that could suggest the central bank saw no need to rush a rate cut.
"The market realised it overdid the (dollar) selling yesterday, as markets often do, and now we're seeing some pretty serious profit-taking," said Joseph Trevisani, chief market analyst at FX Solutions in Saddle River, New Jersey. By late afternoon, the euro was down 0.4 percent on the day at $1.3334. At one point, it fell a full cent from its overnight peak of $1.3411, a two-year high.
Recent worries about the health of the US economy, including soft manufacturing data and rising defaults in home loans to borrowers with impaired credit, have weighed on the dollar. Even so, analysts said the Fed's change of tone suggests the central bank is making sure it steers the economy into a soft landing.
That has helped boost global equities and prompt investors to wade back into so-called carry trades, which involve borrowing low-yield currencies such as the yen to buy currencies and assets with higher yield - and higher risk.
The dollar was up 0.4 percent to 118.11 yen and up 0.4 percent at 1.2140 Swiss francs. Meanwhile, the high-yielding Australian dollar hit a fresh 10-year high of US $0.8087. Investors expect Australia's central bank to raise rates as early as next month.
"The carry trades have come back in favour again, with the equity markets warming up a little bit to the Fed. That suggests investors are generally not risk-averse at the moment, that they are putting money back into the carry trade," said Shaun Osborne, chief currency strategist with TD Securities in Toronto.
The dollar also got a lift from a report showing the number of people filing new claims for jobless benefits unexpectedly fell last week to its lowest in six weeks.
Trevisani said such data showing the labour market remains healthy should ease fears that subprime mortgage defaults will damage the broader economy by limiting access to credit and slowing consumer spending. But he said it would take further dissipation of those concerns for the euro to slip further toward the $1.30 level seen earlier this year.
To that end, investors will be looking ahead to Friday's report on US existing home sales. The median estimate of economists polled by Reuters has sales falling to 6.31 million units in February from 6.46 million the month before.