The dollar was on track for its worst weekly performance in over a year on Friday, hit by soft US data and a rise in risk aversion following the assassination of Pakistani opposition leader Benazir Bhutto. Bhutto's killing after an election rally on Thursday plunged nuclear-armed Pakistan into one of the worst crises in its 60-year history.
With investors less willing to take on risk, equity markets fell, gold held near one-month highs and foreign exchange carry trade bets funded by cheap borrowing in the yen were unwound, boosting the Japanese currency. Combined with a run of weak US data, it also gave investors the excuse to take profits on the dollar's recent bull run in thin trading between Christmas and new year holidays in the world's major financial centres.
Softer than expected US durable goods orders for November and a weak housing market report for October from the S&P/Case-Shiller index have backed expectations for Federal Reserve interest rate cuts next year.
"It's a combination of general lack of risk appetite in the wake of what's going on in Pakistan, and secondly some rather weak US data out in the last couple of days, not least the durable goods and housing numbers," said Russell Jones, head of fixed income and currencies global research at RBC Capital Markets.
"That's hit the dollar quite a lot in pretty thin markets."
By 1110 GMT, the dollar was down half a percent against a basket of major currencies at 76.206, bringing its losses for the week to 1.9 percent and putting it on track for the worst weekly performance since late November 2006.
More bad news for the US economy, and thus for the dollar, could come with the release of the new home sales figures for November at 1500 GMT.
"All the expectations (for the data) are on the soft side so I think the dollar is at risk of further decline," Jones said. According to Reuters data, the dollar hit two-week lows at 112.71 yen, 1.1275 Swiss francs and $1.4713 per euro.
Sterling rose above the psychologically key $2 mark for the first time in over a week. But against the euro, the pound slipped to fresh record lows of 73.56 pence after news of slowing UK house price inflation reinforced expectations for more Bank of England interest rate cuts in early 2008.
Japanese financial markets will be closed from Monday to Thursday next week, reopening for a half day on January 4. Several European centres including Germany will be closed on Monday, and all major markets are closed on Tuesday for New Year's Day. "Markets remain thin and the dollar is vulnerable to some profit-taking as we move towards year-end," Brown Brothers Harriman said in a research note.
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