NEWS / Foreign Exchange

FOREX-Dollar regains poise, Fed minutes eyed for direction

(Updates prices, adds comments)

By Katie Hunt

LONDON, May 31 - The dollar regained its poise on Wednesday after a steep fall the previous session and before the release of Federal Reserve minutes that should shed light on whether U.S. interest rates are close to a peak.

Minutes from the Fed's May 10 meeting due at 1800 GMT will be scrutinised for clues on whether the central bank is going to hike rates to 5.25 percent in June or stay pat.

"I think the minutes will lend support to the view that rates will be on hold and that could be dollar negative to a certain degree," said Ian Gunner, head of foreign exchange research at Mellon Bank.

Many investors say the Fed, which has raised rates at 16 straight policy meetings since mid-2004 to 5 percent, is in a difficult position as it needs to weigh the potential for higher inflation and concerns about a slowdown in the housing sector.

The yen briefly rose after the Chinese central bank reaffirmed its commitment to deepen foreign exchange reform and boost the flexibility of its currency.

The yen is commonly traded as a proxy for the Chinese yuan and investors reckon greater flexibility in China's currency regime could lead to other countries in Asia -- including Japan -- allowing greater foreign exchange moves.

DOLLAR STABILISES

The dollar posted its biggest one-day loss against a basket of currencies since early January <=USD> on Tuesday as the nomination of Goldman Sachs Chairman Henry Paulson to succeed John Snow as treasury secretary did little to dispel the notion that Washington wants a weaker dollar.

"The market hasn't got the momentum to whack the dollar further at the moment. The China news is significant but its impact will be felt in the longer term," said Tony Norfield, head of foreign exchange research at ABN AMRO.

By 1150 GMT the dollar was little changed from the U.S. close at 112.20 yen <JPY=> after falling as low as 111.46 yen on the China news. The euro was a touch weaker at 144.26 yen <EURJPY=>.

The dollar was also little changed against the euro at $1.2862 <EUR=> after the single currency met technical resistance around $1.29.

On the back of Tuesday's broad move lower in the U.S. currency, the Canadian dollar hit a 28-year high against the greenback at C$1.0932 <CAD=>.

Before the Fed minutes, market will focus on the Chicago PMI for May, a measure of business activity in the U.S. Midwest, due at 1400 GMT.

EURO ZONE RATE VIEW

The euro held steady after data showed euro zone inflation at 2.5 percent in May, up from 2.4 percent in April and above a forecast of 2.4 percent.

The data is likely to support expectations of further euro-supportive interest rate rises in the euro zone this year, with the European Central Bank expected to raise rates by at least a quarter of a percentage point next week.

Traders said the dollar would remain vulnerable to the perception, which developed after the Group of Seven finance ministers met last month, that Washington wants to see the dollar gradually fall to reduce the huge U.S. current account deficit.

Although current Treasury chief Snow has repeatedly said he supports a strong dollar, his remarks have fallen on deaf ears as many in the market suspect he favours a weaker currency to support U.S. export industries.

"The market is thinking that Paulson may not really fight the declining dollar, so that's putting the dollar under pressure. And China adds to the sentiment which is starting to be a little bit dollar-bearish," said Antje Praefcke, currency strategist at Commerzbank Corporates and Markets in Frankfurt.