The US dollar jumped to a two-year high on Wednesday as a deteriorating global economy and concern that financial market stability is still too far away spurred investors to liquidate risky assets. The dollar climbed to a two-year high against the euro and a five-year peak against sterling, with analysts citing remarks by Bank of England Governor Mervyn King on Tuesday that the British economy was probably entering its first recession in 16 years.
Fears of a global recession have seen US-based investors selling their assets in both developed and emerging markets and bringing the money back home, boosting the dollar. At the same time, major central banks, excluding the Federal Reserve, are expected to aggressively cut interest rates to shore up growth, lending the dollar more support.
The yen climbed to it's highest against the euro since November 2003, with the low-yielding Japanese currency also benefiting from the exodus from risky assets after being dogged by carry trades for years. Carry trades are strategies in which risk-taking investors borrow cheaply in low-yielding currencies such as the yen then invest the debt in the assets of countries offering higher returns.
On Tuesday King said, "Not since the beginning of the First World War had our banking system been so close to collapse. We are far from the end of the road back to stability."
Analysts said these remarks heightened fears about a global recession and reminded investors that while governments globally had taken aggressive steps to shore up the financial sector it could take a while to see results. The euro fell as far as $1.2740, according to electronic trading system EBS, its lowest since November 2006. It was last down 1.7 percent at $1.2830, according to Reuters data.
The British pound dropped to $1.6153, its weakest in five years. It was last down 2.7 percent at $1.6240. The ICE Futures US dollar index, which measures the dollar's value against a basket of major currencies, climbed to a two-year high of 85.921, before pulling back slightly to be up around 1.4 percent at 85.588.
Analysts reckon the euro could find some support versus the dollar around $1.2500 in the near term and stage a rebound back above $1.3000. "The dollar is overbought in terms of technicals (and) it's probably coming up against some strong resistance here in the short-term," said Michael Woolfolk, senior currency strategist at the Bank of New York Mellon in New York.
"This over-reaction to King's comments is most likely to dissipate and we should see a relief rally in the euro. We should be back above 1.30 if not 1.35 before next week."
Despite the dollar's broad gains, it fell 2.7 percent to 97.660 yen as the ongoing unwind in carry trades extended the Japanese currency's rally with a session low of 97.250. The dollar's losses were also compounded by a sharp drop in stocks on Wall Street.
The euro dropped as low as 124.66 yen, its lowest level since November 2003, according to Reuters data. It was last down 4.4 percent at 125.29 yen. Underscoring the global recession fears, US crude oil fell to its lowest since June 14, 2007 at $66.20 before settling at $66.75. High-yielding currencies were hammered against the yen, with sterling dropping as low as 157.19 yen, according to Reuters data. The Australian dollar fell to 64.96 yen and the New Zealand dollar dropped to 56.87 yen.