Dollar Rises Most Since 2005 as Bernanke Cites Reduced Risk

By Bo Nielsen

June 14 (Bloomberg) -- The dollar rose the most against the euro since 2005 as Federal Reserve Chairman Ben S. Bernanke said economic risks have faded, raising speculation policy makers will increase borrowing costs this year to contain inflation.
The greenback rose to a one-month high this week as Treasury Secretary Henry Paulson declined to rule out intervention to support the dollar and U.S. retail sales increased in May twice as much as economists forecast. Group of Eight finance ministers meeting this weekend in Japan may signal that they favor a stronger U.S. currency.
``Risks to U.S. growth have been reduced, and the market is now thinking the Fed will hike in August,'' said Meg Browne, a senior currency strategist at Brown Brothers Harriman & Co. in New York. ``That's a big shift, and the effect on the dollar was positive.''
The dollar increased 2.5 percent to $1.5380 per euro, from $1.5778 on June 6. It touched $1.5303, the strongest level since May 8. The U.S. currency rose 3 percent to 108.19 against the yen, from 104.93, and touched 108.38, the highest since Feb. 14. It was the biggest gain since December 2004. Japan's currency fell for a fifth consecutive week against the euro, decreasing 0.6 percent to 166.35, from 165.64. It's the longest stretch of gains since October.
``We've seen a very sharp reversal of sentiment about the dollar,'' said Nick Bennenbroek, head of currency research at Wells Fargo & Co. in New York. ``The U.S. economy seems reasonably resilient, and the Fed is beginning to look hawkish.''
Chinese Yuan
The Chinese yuan rose for a second consecutive week versus the dollar, increasing 0.3 percent to 6.9022, on speculation policy makers are seeking a stronger currency to control inflation. The U.S. wants China to keep allowing its currency to rise against the dollar and will discuss that stance in talks next week in Maryland, said Alan Holmer, the U.S. Treasury's top China negotiator, in a briefing in Washington yesterday.
The Australian dollar fell 2.6 percent this week against its U.S. counterpart, the biggest decline in almost three months, and the New Zealand currency declined 2.4 percent, for its third consecutive weekly decrease. Traders speculated an increase in U.S. interest rates will narrow the yield advantage of Australian and New Zealand debt.
Fed funds futures on the Chicago Board of Trade show a 60 percent chance the U.S. central bank will increase the 2 percent target lending rate by at least a quarter-percentage point at its August meeting, compared with 9 percent odds a week ago. There are 21 percent odds policy makers will lift the rate to 3 percent by December.
Yield Spread
The yield advantage of a two-year German bund over a comparable Treasury note fell to 1.58 percentage points, making dollar-denominated assets more attractive. The difference was 2.26 percentage points on June 6, the widest since 1993.
``People are getting ahead of themselves'' betting on Fed rate increases, said David Powell, a currency strategist at Bank of America Corp. in New York. ``The dollar is a bit overshot at this stage.'' He predicted the Fed will raise borrowing costs to 2.25 percent this year.
U.S. retail sales increased 1 percent in May, following a revised 0.4 percent advance the prior month, the Commerce Department reported on June 12. Consumer prices rose 0.6 percent last month after a 0.2 percent increase in April, the Labor Department reported yesterday in Washington.
``The risk that the economy has entered a substantial downturn appears to have diminished,'' Bernanke said in a speech at a Boston Fed conference on June 9. ``The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations.''
Bernanke on Currency
Bernanke said on June 3 that he's aware of the impact a falling currency can have on price expectations. Paulson said in an interview with CNBC on June 9 that he would ``never'' rule out currency intervention.
The 15-nation euro weakened yesterday as Irish voters turned down the European Union's new governing treaty, a setback for the bloc's plans to strengthen its global voice.
French Finance Minister Christine Lagarde, before meeting with her G-8 counterparts in Osaka, Japan, told reporters that the U.S. dollar's increase versus the euro is ``very satisfying.'' The group comprises the U.S., Japan, Germany, the U.K., France, Italy, Canada and Russia.
``If the G-8 this weekend doesn't come out with a stronger statement, the gains we have seen in the dollar this week will disappear very soon,'' said Michael Metcalfe, London-based head of macro strategy at State Street Global Markets, in an interview on Bloomberg Television.
Currency Intervention
The last time the major industrialized countries intervened was on Sept. 22, 2000, when they bought the euro after it tumbled 27 percent from its 1999 debut. They last propped up the dollar in 1995, when it sank almost 20 percent in four months against the Japanese yen to a post-World War II low of 79.95. Central banks intervene in currency markets by arranging purchases or sales of foreign exchange.
The yen weakened this week after Bank of Japan Governor Masaaki Shirakawa and his six colleagues left the overnight lending rate at 0.5 percent, the lowest among major economies, in a unanimous vote in Tokyo.

To contact the reporter on this story: Bo Nielsen in New York at bnielsen4@bloomberg.net
Last Updated: June 13, 2008 19:07 EDT