Dollar Drops Most in June as Fed Seen Damping Rate Expectations

June 23 -- The dollar dropped the most this month against the euro on speculation the Federal Reserve will temper expectations for an interest-rate increase this year in an attempt to lower borrowing costs.

The central bank will probably keep its benchmark rate close to zero and continue its $300 billion program of Treasury purchases, according to a Bloomberg News survey of 58 economists before tomorrow’s statement. The pound fell versus the euro by the most in almost three weeks after Bank of England Chief Economist Spencer Dale said a weaker currency was a “key channel” to spur economic growth.

“A later rate hike by the Fed, or a lack of a rate hike in the near term, would be somewhat negative for the dollar just from a relative interest rates perspective,” said Vassili Serebriakov, a strategist at Wells Fargo & Co. in New York.

The U.S. currency weakened as much as 1.58 percent to $1.4085 per euro, the most since May 29. It traded at $1.4076 at 12:21 a.m. in New York, from $1.3865 yesterday. The greenback dropped 0.8 percent to 95.13 yen. Japan’s currency depreciated 0.8 percent to 133.97 per euro.

Rates on U.S. 10-year notes and 30-year mortgages rose to 4 percent and 5.59 percent, respectively on June 11, the highest this year. The increase threatens the Fed’s plans to free up lending in credit markets by purchasing debt ranging from government notes to mortgage-backed securities.

‘Damper on Yields’

“The market is worried that the Fed will put a damper on yields and that will take away support from the dollar,” said Henrik Gullberg, a currency strategist in London at Deutsche Bank AG, the world’s biggest foreign-exchange trader. “That’s the main reason the dollar looks vulnerable right now.”

Sterling fell 1.2 percent to 85.87 pence per euro after Bank of England’s Dale said in a speech that the central bank’s buying gilts from foreign investors can benefit the economy through a weaker exchange-rate. The U.K. currency has gained 9 percent versus the euro and 12 percent against the dollar in the last three months on signs the U.K.’s recession is abating.

“The BOE’s comments have been used as an excuse to sell sterling,” said Daragh Maher, deputy head of global foreign- exchange strategy in London at Calyon, the investment-banking unit of Credit Agricole SA. “The market has been looking for an argument to sell sterling and Dale’s comments fit the bill.”

The Australian and New Zealand dollars gained, after losing more than 2 percent yesterday. The Aussie rose 1 percent to 798.37 U.S. cents and the New Zealand’s dollar added 1.5 percent to 63.86 cents.

FOMC Meeting

The U.S. currency dropped versus the yen for a third day as the Federal Open Market Committee’s two-day meeting started. Futures traders cut bets the Fed will raise interest rates by at least a quarter-percentage point to 0.5 percent by December, lowering the odds to 40 percent from 49 percent a week ago.

U.S. households may take 15 years to rebound from their losses of wealth during the recession, Edmund Phelps, a professor at Columbia University and winner of the 2006 Nobel Prize for economics, told Bloomberg Television yesterday.

The dollar will emerge from this week’s Fed policy meeting “better biased to weaken,” said Credit Suisse Group AG.

“The dollar’s immediate problem is market concern about the Fed’s inflation-fighting credibility,” a team of Credit Suisse currency strategists led by Ray Farris in London wrote in a note today, referring to the Fed’s purchases of assets. “We see ways for the Fed to salve some of these concerns, but we doubt the Fed will turn hawkish enough to support the dollar,” Credit Suisse said.

Home Resales

Manufacturing activity in the central Atlantic region accelerated this month and U.S. home resales climbed in May, according to data published today by the Fed and National Association of Realtors. The Richmond Federal Reserve Bank’s index of current activity climbed to six from four and existing home sales advanced 2.4 percent to an annual rate of 4.77 million, less than the 4.823 million economists had forecast.

The European Central Bank has already used up the extra space it had to cut interest rates after the “dramatic worsening” in the economy and decline in inflation risk, council member Axel Weber said at an event in Munich today.

The central bank kept its benchmark rate at a record low of 1 percent this month and plans to offer banks 12-month loans for as much as they want in a new auction this week to help credit start flowing again.

The currencies of Asia’s developing nations will strengthen over the next 12 months as accelerating economic growth helps attract funds, according to Citigroup Inc.

The Indian rupee will gain 8 percent in a year’s time on “increased capital flows,” while China’s yuan won’t resume its appreciation until next year as policy makers use a stable currency to aid exporters, analysts including Jeremy Hale, the bank’s London-based head of macro strategy, wrote in a report published yesterday.