The dollar rose against the euro on Tuesday on fear some euro zone states won't be able to withstand higher interest rates, though further gains will likely require the Federal Reserve to hint at tighter policy. Tough inflation talk from European Central Bank President Jean-Claude Trichet last week pushed the euro above $1.40 on expectations of an increase in euro zone interest rates by as early as next month.
Recent credit downgrades for Greece and Spain reminded investors higher borrowing costs and a stronger currency would make it more difficult for debt-burdened countries to boost growth. "The problem with the interest rate driven trade and Trichet's hawkish comments is that you have to see the other issues behind it," said John McCarthy, director of foreign exchange at ING Capital Markets in New York. "Higher rates will be devastating on the peripheral countries."
That helped push the euro down as low as $1.3860, extending a retreat from Monday's four-month peak of $1.4036. It last traded down half a percent at $1.3898. The dollar also rose 0.5 percent at 82.66 yen. Whether the greenback can extend gains against the euro will depend on whether the Fed hints at monetary tightening of its own. US interest rates have been near zero for more than two years and the Fed has poured even more money into the economy via direct purchases of Treasuries.
The Fed holds its next policy meeting on March 15. Following a break of the $1.3862 February peak, the next technical level is $1.3830, the low hit last Thursday before Trichet spoke. Then the euro could be heading toward $1.35, though investors say it is still supported by expectations the ECB may raise interest rates next month.
Euro zone countries are ironing out measures to resolve the region's debt crisis in time for a European Union summit March 24-25. They will meet at a preliminary summit on Friday and any sign leaders are struggling to reach a consensus on a debt rescue fund could trigger more profit-taking in the euro. "We have constructive expectations for reform of the EU financial stability fund. If those aren't realised, we could see negativity on the euro in the short term," said Carl Hammer, currency strategist at SEB in Stockholm.
An early slide in oil encouraged investors to sell the Swiss franc, which has gained broadly from safe-haven buying throughout the political uprising in Libya. The euro traded at 1.3006 francs, having hit a two-week high of 1.3041 francs on EBS.
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