Risk Appetite Weighs on Dollar

Risk appetite was lifted after the Federal Reserve’s meeting on Wednesday as the central bank maintained its commitment to keep US interest rates at ultra-low levels for an “extended period”.

The wording was crucial because speculation that the Fed might omit the phrase had interpreted the possible move as a sign that loose monetary policy would come to an end sooner than anticipated.

This had boosted both the dollar and the yen as haven demand for the low-yielding currencies heightened appetite for risky assets such as equities, commodities and higher-yielding currencies faltered.

The reassurance from the Fed helped reverse that trend, however, sending the dollar and the yen lower.

Meanwhile, investor confidence was also lifted as the European Central Bank and the Bank of England signalled on Thursday that special liquidity measures and asset purchases could now start winding down.

Jean-Claude Trichet, ECB president, indicated that an offer of unlimited emergency one-year liquidity planned for December would be the last.

The Bank of England slowed the pace of quantitative easing in the UK, announcing a £25bn extension of its asset purchase programme to £200bn. This was lower than some had been expecting and reflected what the central bank regarded as a slightly better economic outlook.

Hans Redeker at BNP Paribas said while the market regarded these moves by central banks as a show of confidence in the recovery, high levels of risk appetite were likely to persist, providing support for pro-cyclical and higher-yielding currencies at the expense of the dollar.

“However, any signs that the global recovery is stalling will risk the market viewing the central bank signals of liquidity unwinding as too early and will trigger a reversal of investor sentiment,” he said.

Data on Friday that showed US unemployment rose to a 26-year high failed to temper the dollar’s fall. Indeed, with other economic data in the week and the outcome of central bank meetings broadly supportive of risk appetite, the dollar lost ground over the week. It fell 1.3 per cent to $1.4907 against the euro, dropped 1 per cent to $1.6585 against sterling and lost 1.2 per cent to SFr1.0130 against the Swiss franc.

The yen fell 0.3 per cent to Y89.91 against the dollar over the week.

Commodity-linked currencies also advanced. The New Zealand dollar climbed 1.8 per cent to $0.7262 against its US counterpart over the week, while the Canadian dollar rose 1.7 per cent to C$1.0660 and the Norwegian krone gained 1 per cent to NKr5.6745.

The Australian dollar was the star performer, however, after the Reserve Bank of Australia raised interest rates by 25 basis points to 3.5 per cent. Prospects were further enhanced on Friday after the RBA lifted its 2009 growth forecast to 1.75 per cent, well ahead of the estimate of 0.5 per cent it gave in August.

Over the week, the Aussie dollar rose 2.5 per cent to $0.9194 against the US dollar and 2.8 per cent to Y82.71 against the yen.

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