The US dollar rose sharply on Friday, posting its largest daily increase against the euro in almost three years, after strong US consumer price data trimmed expectations for further interest rate cuts by the Federal Reserve.
The dollar rallied against major currencies for the third consecutive week, bolstered by a string of US economic reports showing higher-than-expected growth in consumer spending and higher inflation, though the data eased some concern that the credit crisis would drag the US economy into a recession.
US consumer price inflation rose to 4.3 percent for the November year, its highest level since June 2006, while the core rate excluding volatile food and energy prices rose to 2.3 percent for the year, limiting the Fed's ability to cut interest rates in 2008.
"More evidence of rising US inflation underlines the Federal Reserve's policy bind and raises chances the central bank will stick to non-interest rate easing liquidity solutions for the struggling money market," said Ashraf Laidi, chief currency analyst at CMC Markets USA in New York.
That should "spare the US currency from interest rate cuts and help it from a relative yield perspective," he added. By mid afternoon, the euro fell 1.4 percent to $1.4420against the dollar, the lowest since late October, according to Reuters data. The euro is on track to post its largest daily fall since at least January 2005.
"We think this can go for another couple of cents, with the euro probably headed initially to $1.4360 or so and maybe as far as $1.40," said Marc Chandler, global head of FX strategy at Brown Brothers Harriman in New York.
"Our view is that dollar weakness has been driven by cyclical influences, not structural ones. Now that the UK and Canada are cutting rates, it looks like the dollar has bottomed against those currencies," he added.
The New York Board of Trade's dollar index, which tracks the greenback's progress against six major currencies, was up 1.1 percent at 77.406, on pace to post its biggest daily gain since January 2006. Against the yen, the dollar rose 1.0 percent to 113.30, after rising to a five-week peak at 113.59.
Since global credit market conditions worsened again in November, in a replay of the crisis that gripped investors in August, the dollar has staged a recovery. Hedge funds, corporate accounts, and institutional investors have all shifted their bets in favour of the dollar and sold off the euro since mid November, according to client flow data from Citigroup.
However, liquidity is thin given the approaching year end, exaggerating price action and making it unclear whether the dollar can sustain a recovery into the new year, traders said. Strategists at BNP Paribas believe US investors will repatriate their profits from abroad and seek relative safety in the depth of domestic markets.
"The dollar is likely to outperform in the coming weeks," the bank said in a note. "Asset markets remain nervous with little optimism on this week's central bank action ... Asset market volatility is dollar positive as the dollar benefits from repatriation related flows and safe haven flows." The Australian dollar fell 1.8 percent to US $0.8605, the lowest since late September. Sterling dropped 1.2 percent to $2.0167.
The Fed cut its benchmark federal funds rate by a quarter percentage point to 4.25 percent on Tuesday, and together with other major central banks unveiled the next day a plan to inject liquidity into medium term money markets to ease the global credit crunch.
Dollar, euro and sterling London interbank offered rates (Libor) all fell on Friday for the second straight day following Wednesday's co-ordinated central bank liquidity plan. However, the magnitude of decline was still modest, suggesting it will take time before banks become comfortable lending to each other again.