Dollar drops but yen bounces back

The dollar fell sharply Wednesday after data showed US manufacturing activity contracted last month, intensifying fears of impending recession in the world’s largest economy.

The much lower-than-expected figure – the weakest since April 2003 – triggered risk-aversion that rippled through foreign exchange markets.

The yen shot up and high-yielding currencies fell as investors unwound risky carry-trade positions.

“Today’s release suggests that corporate activity is weakening significantly, making a further 25 basis point cut by the Fed on January 30 look a very strong probability,” said Rob Carnell, at ING.

The dollar fell 1 per cent against the euro to $1.4738, and 1.4 per cent against the yen to Y110.

The yen also strengthened sharply against high-yielding currencies such as the New Zealand dollar and the Australian dollar.

“People are taking risk off the table,” said Hans Redeker, at BNP Paribas.

The yen’s sharp rise against these currencies indicates that investors are pulling out of the carry trade, which involves borrowing in cheap currencies such as the yen to buy higher-yielding ones.

The yen jumped 1.5 per cent against the New Zealand dollar to Y84.72 and 1.4 per cent against the Australian dollar to Y96.65. Against sterling it was up 2.2 per cent at Y217.41.

Sterling was undermined by weak purchasing manager’s data in the UK.

“With signs that growth and inflation pressures are moderating in the manufacturing sector there is the growing prospect of further policy easing in coming months. We suspect rates will be cut to 4.75 per cent by the end of the year,” said James Knightley at ING.

The pound fell 0.3 per cent against the dollar to $1.9791 by midday in New York.

In contrast to the US and UK data, European manufacturing numbers showed activity in the eurozone was resilient, boosting the euro to an all-time high against sterling.

“We expect the ECB to keep up its hawkish rhetoric, but to nevertheless leave its key interest rate at 4 per cent for many months to come,” said Howard Archer at Global Insight.

The single currency rose 1.4 per cent to £0.7450 by midday in the US.

The Kenyan shilling fell to a six-week low as violence intensified. It fell 5.5 per cent to the dollar to Ks67.20 in thin trade, with traders adopting a wait-and-see approach ahead of a large opposition march planned for Thursday in Nairobi.

China’s renminbi hit a post-revaluation high as the country’s central bank continued to set higher daily mid-points from which the currency is allowed to fluctuate. The renminbi ended 0.1 per cent higher at Rmb7.2934.