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Dollar at 2008 highs as oil's tumble gathers pace

Filed on September 2, 2008

LONDON - The dollar extended its rally to new 2008 highs against a basket of currencies on Tuesday as falling oil prices fanned expectations of lower global inflation rates and monetary policy easing outside the United States.

The euro fell seven-month low against the resurgent dollar, sliding below $1.45. Combined with an increasingly bleak UK economic outlook, the dollar's broad strength pushed sterling further below $1.80, to its lowest since April 2006.

The pound also plumbed new record lows against the euro and a 12-year low against a basket of currencies.

The overriding theme driving financial markets on Tuesday was oil's tumble to $105.46 per barrel following Hurricane Gustav's downgrade on Monday to Category 2.

Oil has fallen almost 30 percent from July's record peaks near $150. That prompted traders to bet global inflation would ease in the coming months, giving central banks room to deliver growth-supportive interest rates cuts.

Australia's central bank cut rates by a quarter percentage point earlier on Tuesday to 7 percent, helping drive the Australian dollar down sharply to its lowest in a year.

Base rates in the United States have already been slashed in the past year, to 2 percent, while Japanese rates are at 0.50 percent. These rates are unlikely to go much lower.

"It does look like there's market capitulation in oil prices and that is helping the dollar to strengthen," UBS currency strategist Geoffrey Yu said.

"The market is shifting towards a view ... where the U.S. economy is in a more advanced stage of an economic adjustment than other economies. Investors are allocating money back into the U.S., trying to capture this bounce ahead of time."

At 1114 GMT the euro was down 0.8 percent on the day at $1.4481, below $1.45 for the first time since February and more than 15 cents off the record high scaled in mid-July.

Sterling set a two-year low of $1.7784 before pulling back to $1.7805, down 1.1 percent. The dollar index rose 1.3 percent to 78.165, having earlier hit a 10-month high of 78.274, and has racked up gains of 10 percent since mid-July.

The Australian dollar fell more than two percent to $0.8270 , its lowest in a year, after the central bank rate cut.

The dollar was up 0.7 percent against the yen at 108.83 yen , above a one-month low of 107.62 struck the previous day.

ECB looms

Liquidity in the global foreign exchange market was returning to more normal levels as the U.S. markets were set to open after Monday's Labor Day holiday.

Attention is seen turning later this week to the press conference which European Central Bank chief Jean-Claude Trichet will hold after Thursday's policy meeting at which the ECB is expected to leave interest rates unchanged at 4.25 percent.

With oil prices falling sharply, investors will seek signs that Trichet's anti-inflation rhetoric is cooling.

Maurice Pomery, head of currency strategy at IDEAGlobal, noted the RBA was until recently one of the most hawkish central banks: "I strongly believe others will follow sooner than expected," he said, with the possible exception of the ECB.

Sterling was under heavy selling pressure after Britain's finance minister said at the weekend that economic challenges were the greatest in 60 years. It fell further on Tuesday to hit a 12-year low on a trade-weighted measure at 88.5, with the euro rising to a record high of 81.62 pence.

British Prime Minister Gordon Brown cut an unpopular tax on home purchases as part of a package to boost the country's slumping housing market but the package was given short shrift.

"The view is probably 'too little too late'," said Kamal Sharma, G10 strategist at JP Morgan.

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