FOREX-Dlr slides towards record low vs euro, ZEW eyed

Tue Jul 15, 2008 4:19am EDT

* Euro up 0.7 percent, hits 3-mth high at $1.5993, seen

testing record above $1.60

* Dollar seen vulnerable on financial system worries

* German investor morale seen holding near 15-yr low

* Market closely watching Bernanke testimony

(Changes dateline, byline, adds quotes, updates prices)

By Veronica Brown
LONDON, July 15 (Reuters) - The dollar dropped towards a record low versus the euro on Tuesday as an initially positive response to the U.S. government's mortgage bailout plan turned sour, leaving wider concerns about its financial system.

The rescue package, aimed at shoring up confidence in mortgage agencies Freddie Mac and Fannie Mae, was interpreted as underscoring the severity of credit market problems stemming from a hobbled housing market.

That, coupled with the inflationary effects of record high oil prices, was seen heaping further pressure on the buckling U.S. economy.

Late on Sunday the Treasury said it would boost its direct credit lines to the companies that fund nearly half of all U.S. mortgages and buy their shares if necessary, while the Fed opened its direct lending facility to them.

"There's a severe risk that all the stock owners in Fannie Mae and Freddie Mac will lose their money ... and that can become a severe risk for the economy, that all consumption will disappear," Danske Bank senior FX strategist John Hydeskov said.

"We saw it (dollar's relief rally) as a very welcome buy opportunity in euro/dollar. It seems quite inevitable that the pair will reach $1.60 in the near future," he added.

Shares of major U.S. banks also plunged on Monday amid fears about the sector's stability after regulators seized IndyMac Bancorp as withdrawals by panicked depositors led to the third-largest U.S. bank failure.

The euro rose 0.7 percent to $1.5993 -- scoring a three-month high close to the April 22 record of $1.6018, according to Reuters data.

Against a basket of six major currencies .DXY, the dollar was down 0.4 percent at a three-month trough of 71.515.

Tumbling stock markets in Asia and Europe also sent investors towards the safe-haven Japanese yen. The dollar fell 0.8 percent to 105.33 yen , while the euro eased 0.2 percent to 168.43 .

BERNANKE, ZEW EYED

Traders said they were closely watching Fed Chairman Ben Bernanke's testimony before Congress later in the day to see how the latest financial system strains affect his views on monetary policy and the economy.

"Bernanke will try to walk the fine line between the need for price stability (and implicit support for USD) versus aid for financial markets. While he may try to opt for a hawkish line today, we would sell into any USD strength, betting that the Fed will not hike rates before the election," ING said in a note to clients.

But before that in Europe, Germany's ZEW investor morale gauge is due at 0900 GMT with analysts polled by Reuters expecting that sentiment among investors remained near its worst level in more than 15 years this month .

Danske's Hydeskov remained bullish on the euro's chances of gaining traction against the dollar despite expectations for the ZEW to make grim reading.

"The ZEW indicator is definitely on a declining trend, but it's still not matching the bad U.S. data flow and that reinforces our belief in a strong euro/dollar," he said.

Elsewhere, the Australian dollar hit a 25-year high against the U.S. dollar of $0.9811 after minutes of the Reserve Bank of Australia's July meeting showed the central bank remained concerned about inflation, suggesting it will likely keep interest rates at a 12-year high. (Reporting by Veronica Brown; Editing by Malcolm Whittaker)