Euro below $1.45 as oil tumble lifts dollar

Tue Sep 2, 2008 9:56am EDT

By Jamie McGeever

LONDON (Reuters) - The dollar extended its rally on Tuesday to fresh 2008 highs against a basket of currencies as oil's startling fall toward $105 a barrel boosted expectations of lower global inflation and non-U.S. interest rates.

The euro fell to its lowest in seven months against the rampant greenback below $1.45, while sterling's dismal run continued and it fell to fresh historical lows.

Compounding an increasingly bleak UK economic outlook, the dollar's broad strength helped push the pound firmly below $1.80 to a fresh low since April 2006, and the pound also made new historical lows against the euro and a basket of currencies.

But the dominant theme driving financial markets on Tuesday was oil's tumble to $105.46/bbl following the downgrade of Hurricane Gustav on Monday to Category 2.

Oil is down almost 30 percent from its record peak just shy of $150/bbl in July. This suggests inflation around the world will come down in the coming months, giving central banks room to deliver growth-supportive interest rates cuts.

Australia's central bank cut rates by a quarter percentage point earlier on Tuesday to 7 percent, helping drive the Australian dollar down sharply to its lowest in a year.

Base rates in the United States have already been slashed in the past year to 2 percent while Japanese rates stand at only 0.75 percent. These rates are unlikely to go much lower.

"What does that mean? We will see mounting rate cut expectations, which means spreads will move in favor of the U.S. dollar and partly in favor of the yen," said Michael Klawitter, head of FX strategy at Dresdner Kleinwort.

"So consequently, the dollar in gaining by default. That's the key driver at the moment - what will we see with rates spreads in 2009."

At 4:30 a.m. EDT the euro was down 0.8 percent on the day at $1.4485 below $1.45 for the first time since February and more than 15 cents off its all-time high struck mid-July.

The dollar index .DXY climbed 1.3 percent to 78.198, a near ten-month high.

The Australian dollar was down 2.1 percent at $0.8340 its lowest in a year, after the Reserve Bank of Australia cut rates a quarter point to 7 percent.

The dollar was up 0.5 percent against the yen at 108.58 yen above a one-month low of 107.62 struck the previous day.

Sterling touched a two-year low of $1.7850 before pulling back to $1.7920, down 0.5 percent.

The Australian dollar fell to $0.8472 and hit a fresh one-year low of $0.8458. It had briefly risen as high as $0.8534 after the rate cut news.

MASSIVE MOVES

The moves, with global FX market liquidity returning to more normal levels as U.S. markets open after the Labor Day holiday on Monday, have been staggering.

Oil is down 8 percent from Friday's settlement close, its biggest one-day fall (because Monday was a U.S. holiday) in over five years and takes its fall from the July peak to almost 30 percent.

The euro is down almost 10 percent from its July peak, sterling has shed more than 10 percent against the dollar in barely a month, and the dollar index has appreciated by 10 percent since mid-July.

All eyes will be on ECB President Jean-Claude Trichet on Thursday when he speaks to reporters after, in all probability, keeping rates on hold at 4.25 percent.

With oil falling sharply, investors will be looking for signs his anti-inflation rhetoric is cooling. Maurice Pomery, head of currency strategy at IDEAGlobal, noted that the RBA was until recently one of the most hawkish central banks.

"I strongly believe others will follow sooner than expected," he said, with the possible exception of the ECB.

But even they will be forced to recognize the changing environment. And if they don't: "Nobody will take then at face value," said Klawitter at Dresdner.

The UK pound, already under heavy selling pressure after Britain's finance minister said at the weekend that economic challenges are the greatest in 60 years, fell further.

It fell 0.8 percent to a two-and-a-half year low against the dollar at $1.7849 a 12-year low on a trade-weighted measure at 88.5 and the euro earlier hit a record high of 81.62 pence.

To the extent that economic data will have any influence on trading Tuesday, attention now turns to euro zone producer prices figures and the latest snapshot of the U.S. manufacturing sector with the August ISM report.