U.S. dollar rallies, shrugs off government spending cuts

NEW YORK Sat Mar 2, 2013 3:33am IST

1 of 3. A picture illustration taken with the multiple exposure function of the camera shows a one Euro coin and a map of Europe, January 9, 2013.

Credit: Reuters/Kai Pfaffenbach

NEW YORK (Reuters) - The wide-ranging U.S. spending cuts that automatically kicked in on Friday and threatened to dampen economic growth did little to diminish a U.S. dollar rally which was aided by upbeat economic data.

The euro sank to a 2-1/2-month low before quickly rebounding while increased speculation the new leadership of the Bank of Japan will move quickly to loosen monetary policy sent the yen reeling.

Sterling collapsed to a fresh 2-1/2-year nadir on disappointing economic data, briefly dropping below the $1.50 level.

The U.S. government hurtled toward making deep spending cuts that threaten to hinder the nation's economic recovery, after Republicans and Democrats failed to agree on an alternative deficit-reduction plan.

"The market is not paying much attention to the sequestration because the buzz is the economic impact is not going to be that strong, certainly not in the short term," said Steven Englander, global head of G10 currency strategy at CitiFX.

Speculation that the European Central Bank may take action to curb economic deterioration gathered pace, with the euro dropping below $1.30 for the first time since December as data showed weakness in the European manufacturing sector while growth in Asia cooled.

Poor euro zone data, along with cooling inflation and the risk that political instability in Italy may push up borrowing costs for struggling countries, could exert pressure on the ECB to lower interest rates in coming months.

In late New York trade, one euro bought $1.3021, off 0.27 percent against the greenback, closing out its fourth consecutive week of losses. Earlier the euro hit a low of $1.2965, its worst point since early December.

The U.S. dollar surged more than 1 percent in value to 93.56 yen, its best one day gain in three weeks.

Disparate factors played to the greenback's favor on Friday, including a positive contrast of U.S. economic data against weak reports from the euro zone and Asia. This all combined to help lift the U.S. dollar index .DXY to a six-month high against a basket of currencies.

Factory activity in China cooled in February to a five-month low while British manufacturing shrank unexpectedly last month. In the last quarter of 2012, a plunge in factory output contributed to a drop in economic activity and put Britain within sight of its third recession since the 2008 crisis.

"The pound got massacred by the data being terrible," said Englander.

Sterling fell 0.84 percent to $1.5032.

DOLLAR REIGNS

The pace of growth in U.S. manufacturing rose to its fastest rate in over a year and a half in February while U.S. consumer sentiment rose in February as Americans were more hopeful that the jobs market will improve.

The dollar's status as a safe haven also worked in its favor against the backdrop of sweeping U.S. spending cuts enacted on Friday. The International Monetary Fund has warned that the cutbacks could knock at least 0.5 percentage point off U.S. economic growth this year and slow the global economy.

"We are living in an unusual world for foreign exchange, where stronger data keeps talk of the end of quantitative easing in 2013 alive, and helps the dollar, while any future weaker data will lead to concerns on global growth that are helpful for the dollar," said Alan Ruskin, head of G10 FX strategy at Deutsche Bank in New York.

"It is this asymmetry that over time obviously adds up to create a positive dollar bias," he said.

Interest rate spreads between two-year U.S. government bonds over their German counterparts gave investors another reason to buy the dollar. Some expect the Federal Reserve to slow its asset purchase program, called quantitative easing, later in the year as the U.S. labor market shows signs of improvement.

In contrast, joblessness in the euro zone rose to an all-time high while business surveys showed manufacturing activity was sluggish in February.

"When you look across Europe, you see high unemployment, barely any growth, apart from Germany, and rising debt levels," said Howard Jones, advisor at money managers RMG Wealth Management. "What Europe needs is growth, easier monetary conditions and a weaker currency."

"The U.S. data in comparison is much better than Europe and to us, the dollar is a buy. We expect the euro to ease towards the mid-$1.20s in the next two months."

(Additional reporting by Julie Haviv in New York and Anirban Nag in London; Editing by James Dalgleish)

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