Dollar mixed as US rate cut talk intensifies

NEW YORK (AFP) - The euro slipped against the dollar yesterday after briefly topping the 1.35 level amid speculation the US Federal Reserve would soon cut its key interest rate.

The euro edged down to 1.3463 dollars around 2100 GMT, from 1.3474 dollars in New York late on Monday. It had climbed as high as 1.3521 dollars in European trading on the rumors of a US rate cut.

The dollar declined to 114.41 yen, from 114.86 yen on Monday.

The US central bank's decision Friday to cut its discount rate -- the rate at which it lends to banks that need short-term liquidity -- sparked rumors of an emergency cut in its main interest rate ahead of a scheduled meeting next month.

"The Fed's statement -- which said the central bank is 'prepared to act as needed' -- has led everyone to believe that it will cut interest rates," said Neil Mellor at Bank of New York Mellon.

The high degree of speculation in foreign-exchange markets has led to trading on rumors rather than fundamentals, leaving markets "hostage to good central bank newsflow," Mellor said.

"The market is very excited about the prospect of a rate cut and an optimism premium is starting to build into asset markets."

The speculation is focused on the Fed's key federal funds rate, which the central bank has held at 5.25 percent since June 2006.

Last Friday, the Fed unexpectedly slashed by a half-point its discount rate for commercial banks to 5.75 percent, further fueling talk of a fed funds rate cut.

The speculation intensified Tuesday after Fed chairman Ben Bernanke, Treasury Secretary Henry Paulson and Christopher Dodd, the chairman of the Senate Banking Committee, discussed the recent financial disruptions.

Dodd told a news conference after their meeting that Bernanke pledged to use "all tools available" to avert a worsening of the housing-related credit problems roiling financial markets.

The senator said Bernanke did not make any specific pledges to him regarding a potential cut in the fed funds rate which would lower borrowing costs for millions of consumers.

Elsewhere, the president of the Federal Reserve Bank of Richmond, Jeffrey Lacker, said in a speech that the volatility in the financial markets "in and of itself, does not require a change in the target federal funds rate."

That did not stop many traders from penciling in a rate cut in the near term.

The Fed's move also put a temporary halt to the rapid unwinding of the yen carry trade, a risky strategy where investors borrow in low-yielding currencies such as the yen to invest in higher-yielding assets elsewhere.

But Mellor said the current global credit turbulence had set the yen carry trade on a firm downward trend.

"A resumption in the yen carry trade is off the table as it is totally reliant on stability in the markets," he commented.

Elsewhere, the dollar edged upwards against some other major currencies as higher-yielding rivals such as the pound and the Australian dollar came under renewed pressure.

Gains were nonetheless tempered by the prospect of a Fed rate cut.