The dollar rose broadly on Thursday but support remained fragile as oil touched new record highs and a gloomier Federal Reserve growth forecast added to fears that the US economy may be heading toward stagflation. Firm euro zone economic data this week and persistent inflation boosted the euro to $1.5814 overnight, a one-month high, but it retreated when investors began taking profits.
A report showing Americans filed fewer than expected applications for first-time jobless benefits also provided a dollar boost, as it showed the US labour market is "still shy of typical full-blown recession levels," said Alan Ruskin, international strategist at RBS Greenwich Capital in Greenwich, Connecticut. But traders said the market remained focused on oil, which jumped above the $135-a-barrel mark, bringing its gains for the year to 40 percent and feeding worries that the United States is sliding into stagflation - a vicious combination of rising inflation and tepid growth.
Still, oil prices eased toward the end of the session and crude settled at $130.81, down $2.36 on the day. "Profit taking dominated the session today, but as oil prices eased a bit, we've seen the dollar extending some of its gains," said Joe Manimbo, a currency trader at Ruesch International in Washington.
In late afternoon trading in New York, the euro was last down 0.5 percent at $1.5703 but remained near the top of a well-worn $1.54-$1.58 range that has persisted for most of the month. Sterling rose 0.3 percent to $1.9783 on stronger-than-expected UK retail sales.
The yen also wilted, as traders expected surging oil prices to hurt Japan's economy, a net importer of energy. The dollar rose 1.2 percent to 104.23 yen while the euro rose 0.6 percent to 163.68 yen. "With oil at $135, every economy and every nation's inflation outlook is at risk," said David Gilmore, a partner at Foreign Exchange Analytics in Essex, Connecticut.
Analysts said the dollar remains doubly vulnerable. On Wednesday, the Fed downgraded its 2008 US economic growth forecast and raised its inflation outlook. "If growth continues to deteriorate, we could run into a stagflation situation where nobody wants to hold dollars," said Robert Kowit, who helps manage a $3 billion bond fund for Federated Investors in Pittsburgh.
"Then you could face a big downside for the dollar, which would force people to look at non-dollar assets in other developed markets to offset their losses," Kowit said. The Fed has cut its target interest rate from 5.25 percent to 2 percent since September, but markets now expect it to hold steady and possibly raise borrowing costs by year end. Persistently high inflation and a rise in German business confidence has increased expectations that the European Central Bank's next interest rate move may be an increase from the current 4 percent.