dollar weakens in rumor-prone market

Dollar weakens in rumor-prone market

By Kevin Plumberg

NEW YORK, March 30 (Reuters) - The dollar on Thursday suffered its largest single-day decline in two months, pushed lower by market chatter that some central banks have started shifting some dollar reserves into other currencies.

The talk about such diversification reignited concerns that the United States may not be able to attract enough foreign capital flows, particularly from China, to offset its huge trade deficit. Some analysts say China, which holds the world's largest foreign currency reserves, may start buying fewer U.S. assets as it slows its accumulation of reserves.

"China is probably going to make some adjustments that include slower reserve accumulation in the future and therefore slower reflow into the United States," said Robert Sinche, global head of currency strategy with Bank of America.

"Throw on top of that talk of some Middle Eastern central banks doing some reserve diversification, all of this leaves some negative structural backdrop to the dollar," he added.

Rumors that the White House had issued a statement in support of a weaker dollar also caused the greenback to fall, accelerating a move partly driven by technical factors, traders said.

The Treasury Department later reaffirmed its usual public stance that a "strong dollar," the value of which is set in open markets, is in the national interest. [ID:nWAT005179]

By early afternoon, the euro was up 1 percent from late Wednesday to $1.2145, just off a session high of $1.2155 and within the $1.18-to-$1.22 range of the past two months.

The euro was also 0.7 percent firmer at 142.57 yen , nearly a two-month high.

Against the yen, the dollar fell 0.3 percent to 117.37 yen .

SHIFTING RESERVES

The dollar's decline gained momentum shortly after 10 a.m. (1500 GMT) when a few option strikes in euro/dollar above $1.21 expired and rumors began to spread rapidly that the White House was seeking a weaker dollar.

Though traders dismissed the validity of the rumor, an article in the New York Times saying the new White House chief of staff wants to replace Treasury Secretary John Snow may have contributed to the talk about a weaker dollar, some traders said.

The dollar's fall on Thursday coincided with a 25-year high in the price of gold [ID:nN30392927] and nearly a 2-year high in the benchmark 10-year Treasury note yield. [ID:nN30986]

The euro was supported by market talk that the United A--rab Emirates would convert more of its reserves of roughly $23 billion into euros. The UAE said earlier in the month that it was looking to convert up to 10 percent of its reserves.

While the issue is hardly new, it struck a chord with traders who believe the Federal Reserve is only at most a few more interest rate increases away from ending its current tightening cycle and removing a crucial support for the dollar.

"Although the potential shift in reserves by the UAE does not represent a huge amount on its own, if this becomes a trend throughout the region, it will have a significant impact on FX markets," said analysts at BNP Paribas in a note to clients.

The dollar had rallied on Tuesday after the Federal Reserve raised rates to 4.75 percent and signaled that at least one more rise would be in the cards. But gains have been eroded since then, with markets speculating that policy could well peak in May at 5 percent.

(Additional reporting by John Parry)

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