NEW YORK – The dollar fell Monday, hurt by traders' firming conviction the strong dollar policy has all but been abandoned, but its decline was reversed by suspicions that the Bank of Japan was selling yen.
Over the near term, analysts say, the euro may break above its launch level.
The dollar recovered from fresh four-year lows against the euro and a two-year trough against the yen, in part helped by St. Louis Federal Reserve President William Poole's remarks that the U.S. economy has the potential to grow much more quickly and that the risk of deflation in the United States is minor.
These remarks contrasted with European Central Bank Governing Council member Ernst Welteke's remarks to Die Welt newspaper that if recent developments in foreign exchange rates continue, that may open up more room for monetary policy actions.
Currency traders took this to mean that the European Central Bank is more likely to cut interest rates, removing part of the advantage of higher-yielding euro-denominated bonds, a consideration that some said checked the euro's ascent.
"Welteke's comments are among more indications that the ECB may go ahead and cut rates. An ECB rate cut would weigh on the euro," said Tim Mazanec, senior currency strategist with Investors Bank & Trust in Boston.
The single European currency's attempt to return to its starting blocks has sent ripples through financial markets and set some analysts betting the euro could reach $1.20 over the near term.
The euro rallied within a fraction of its $1.1747 January 1999 launch level, reaching $1.1738.
The single currency has charged higher against the greenback, driven by traders' view that the Bush Administration has let slip the strong dollar policy. The euro has also been aided by a powerful undertow of capital flows from the United States into higher-yielding euro zone assets.
The euro has gained about 12 percent this year.
At a weekend meeting of Group of Seven finance ministers in France, U.S. Treasury Secretary John Snow ignited a dollar sell-off by intimating to reporters that dollar policy has less to do with the dollar's relative value against other currencies than investor perceptions of the currency as a "good medium of exchange."
Even as Snow expressed a desire for the dollar to be a currency that people are willing to hold, he dismissed the dollar's recent weakness as "a modest realignment."
Traders quickly reacted to Snow's comments by selling the dollar across the board. But they found their offers met by suspected bids from Japanese monetary authorities, who are desperate to keep the yen weak in order to prevent it from undermining a fragile economic recovery.
Recently, the BOJ has used Japanese financial institutions to sell yen as its proxy rather than asking global central banks to act on its behalf. Early Monday, the BOJ, the European Central Bank and the New York Federal Reserve all declined to comment on the suspected covert intervention.
The dollar fell as low as 115.10 yen, its lowest since February 2001, before traders rapidly bought it back, initially to levels above 116.50 yen, up 0.40 percent on the day. The euro surged to a record high against the Japanese unit above 136.20 yen , up 1.30 percent on the day.
Against the Swiss franc, the dollar hunkered at its weakest level since October 1998 at 1.2964, down about 1 percent from its previous U.S. close.