Dollar Drops on Reserve Diversification Talk

MarketWatch.com, December 27, 2006

NEW YORK (MarketWatch) -- The dollar fell against other major currencies Wednesday, after the United Arab Emirates said it's planning to diversify its foreign-exchange reserves away from the U.S. currency.

But the greenback slightly trimmed its losses after a U.S. government report showed sales of new homes rose more than forecast last month. The Commerce Department said sales of new homes rose 3.5% in November to a seasonally adjusted annual rate of 1.047 million homes. Economists surveyed by MarketWatch had expected a reading of 1.02 million homes. October's sales pace was revised upward to 1.013 million, from 1.004 million.

"The better-than-expected new-home sales report will add some weight to notions that the housing market is stabilizing," said Brian Dolan, director of research at Forex.com, a division of Gain Capital. However, "with home builders offering large discounts and incentives to move unsold inventory, it's difficult to say with any conviction that the housing market has turned the corner."

"The drop in unsold inventory is a step in the right direction," Dolan said.

In New York trading, the dollar was quoted at 118.75 yen, compared with 119.11 yen late Tuesday. The euro changed hands at $1.3124, compared with $1.3098.

The British pound traded at $1.9561, compared with $1.9538. The dollar changed hands at 1.2251 Swiss francs, compared with 1.2231 francs.

The euro fetched 155.86 yen, compared with 156.02 yen.

The National Association of Realtors will report sales of existing homes on Thursday. Existing-home sales probably fell to a seasonally adjusted annual rate of 6.20 million units in November, off from October's 6.24 million sales.

Central banks

Sultan Bin Nasser al-Suwaidi, UAE's central bank governor, said the bank plans to raise the share of euro holdings in its reserves to 10% from 2% over the next six to nine months. The bank also said it has started to do so in a "limited way" and will buy euros on pullbacks and sell dollars on periodic highs. UAE's reserves stand at about $25 billion.

"This approach to reserve accumulation is consistent with that of many central banks planning to diversify their reserves without triggering rapid moves in the value of the dollar and the euro," said Ashraf Laidi, chief foreign-exchange analyst at CMC Markets in New York. "Central banks will play an increasingly crucial role in acting as a stabilizer to periodic declines in the single currency."

Currency analysts at Brown Brothers Harriman, noted that while some observers cited the UAE news as a dollar negative, "from a different angle, it illustrates how benign the developments really are," they said, adding that the amount of reserves involved is roughly only $2 billion.

"UAE plans on holding roughly 90% of its reserves in dollars, well above the average above the U.S. dollar share in the world economy or financial assets," they wrote in a research note.
A number of countries, including Sweden, Qatar, Italy and Russia, have announced plans this year to diversify their reserves away from dollars. The Russian, Swiss and New Zealand central banks also said recently that they were increasing their holdings of yen.

January rate hike

Elsewhere, the yen found some support after Japan's Jiji news agency reported said the Bank of Japan will likely discuss a proposal to raise its key overnight call rate target by 0.25 percentage point to 0.5% at its next policy meeting in January.

"The story underpinned yen strength for the session despite retail sales which missed expectations and continued to signal broadly weak consumption in Japan," said Terri Belkas, currency analyst at FXCM.

Japan's retail sales slipped to negative 0.1% on a year-over-year basis in November, down from 0.1% in October and below market expectations for a gain of 0.5%.

Japan's currency fell to a two-month low against the greenback on Tuesday after soft consumer prices and spending reports dampened expectations the Bank of Japan would raise rates soon.

"Yen's gains could be temporary as the BoJ is more likely to hold off until later in the first quarter of 2007 before tightening monetary policy for the first time since July," Belkas said.