Inflation Expectations Strengthen the Dollar

International Herald Tribune, June 1, 2006

The dollar rose against the yen and euro Wednesday after minutes from the Federal Reserve's last meeting showed that the central bank could raise interest rates next month.

The central bank said in its minutes that inflation needed "monitoring."

"If inflation is rising, they need to go ahead and combat that," Tim Mazanec, senior currency strategist in Boston at Investors Bank & Trust, said. "That's going to help the dollar somewhat."

The dollar also gained after a report showed that some regional manufacturing rose in May, further sustaining speculation that the Federal Reserve would lift interest rates.

The report, on manufacturing in Chicago, "points to ongoing strength in the U.S. economy in the manufacturing sector," Brian Dolan, research director at Gain Capital, in Bedminster, New Jersey, said. "It keeps the debate very much alive whether the Fed will tighten in June."

In 4 p.m. trading in New York, the euro fell to $1.2817 from $1.2866 on Tuesday. The dollar rose to ¥112.540 from ¥112.235 and to 1.2185 Swiss francs from 1.2118 francs. The pound fell to $1.8702 from $1.8837.

Central bank officials raised interest rates in May and the policy-setting Federal Open Market Committee meets next in late June. "The key is what the FOMC will be doing in June," Brian Garvey, a senior currency strategist in Boston with State Street Global Markets, said.

Interest rate futures show that traders are pricing in about a 60 percent chance that the Fed will raise its benchmark rate on June 29.

"The Fed has been consistently more dovish," Kathy Lien, chief strategist at Forex Capital Markets in New York, said. "The market is looking for confirmation there may be a slowdown. The dollar could sell off."

The dollar also got support after the Unites States said that it would join European talks with Iran about its nuclear program if Iran halts the enrichment of uranium.

"The Iranian standoff casts a long- term pall on the U.S. dollar," said Dolan of Gain Capital. "It argues for higher oil prices and uncertainty. Both are keeping the dollar weaker than it would be given the solid economic underpinnings."

The yen started to rise Wednesday against the dollar and euro after China's central bank said it would make the yuan more flexible, but it surrendered those gains as traders concluded that China was unlikely to make significant changes to its currency policy, said Adrian Foster, a currency strategist at Dresdner Kleinwort Wasserstein.

A stronger yuan would make it cheaper for China to import goods and make Chinese goods more expensive abroad, helping the economies of its regional competitors.