WORLD FOREX: Dollar Demand Rises On Financial-Sector

NEW YORK Dollar demand is back on a return of financial-sector woes Tuesday.

The Dow Jones Industrial Average is down more than 150 points on the day, dragging currencies associated with risk sentiment, including the greenback's European rivals.

Risk appetite has reversed from last week's rally at the start of earnings season and on a report that says the International Monetary Fund has increased its forecast for toxic debts accumulated by banks and insurers worldwide to $4 trillion.

The U.K. newspaper The Times reported that the IMF may raise its forecast for U.S.-originated assets to $3.1 trillion from $2.2 trillion and Europe and Asia-originated assets to $900 billion.

"Although recent government efforts have reduced the risk of another high-profile banking failure, investor expectations of a swift recovery to health for the financial industry may yet prove premature," said Brian Kim, a foreign exchange analyst at UBS.

The euro and U.K. pound's decline Tuesday also comes after they were unable to break beyond key technical levels Monday before traders took profits off their recent rally.

"We now think there is a material danger that we could see a move [for euro] towards this $1.2750-60 level and feel that likelihood will rise exponentially if we break this $1.3095-$1.3113 level," said technical analysts at Citigroup.

"As a consequence we are establishing an opportunistic short at $1.3274 with a stop loss at $1.3430," they said.

In addition, comments by European Central Bank officials indicate any euro gains based on the bank's relatively careful approach to easing rates will fade.

ECB governing council member George Provopoulos said he doesn't see 1% as a barrier for the refi rate, currently at 1.25%, and that the ECB could cut rates below that level if economic conditions deteriorate.

In a telephone interview with Bloomberg late Monday, Provopoulos - who is governor of the Bank of Greece - was also quoted as saying that the central bank could potentially buy corporate debt to boost lending.

Late Tuesday morning in New York, the euro was at $1.3276 from $1.3414 late Monday. The dollar was at Y100.66 from Y101.0, according to EBS. The euro was at Y133.65 from Y135.49. The U.K. pound was at $1.4760 from $1.4751, while the dollar was at CHF1.1449 from CHF1.1367.

Overnight data did little to support the euro or pound either.

Final official data Tuesday showed the record contraction in the euro-zone economy in the fourth quarter was even sharper than initially estimated. Gross domestic product contracted 1.6% on the quarter and 1.5% on the year in the final three months of 2008, the biggest contraction by both measures since records began in 1995, the European Union's Eurostat statistics agency said.

In addition, U.K. manufacturing output declined for the 12th straight month in February, down 0.9%. However, compared with a revised 3.0% drop in January, this was the smallest monthly drop since August 2008.

Elsewhere, the Reserve Bank of Australia on Tuesday cut interest rates a further one quarter of a percentage point to a 49-year low of 3.0%, saying the economy is contracting, but at a slower pace than other major economies. The bank indicated a more neutral policy stance and said there are early signs of improvement in the world economy, including in China, Australia's largest trading partner.

The initial impact was positive on the Australian dollar. However, Barclays Capital analysts indicate that local banks are unlikely to pass through the entire cut to borrowers. This "may put pressure on the RBA to cut rates further and likely unwind most of the Australian dollar's immediate post-RBA gains," they said.

The Bank of Japan voted unanimously to hold interest rates steady at 0.1%. The bank also widened the range of acceptable collateral for its money-market operations, a bid to get more funds to struggling banks and businesses.

Meanwhile, ECB Board member Juergen Stark said the decision by leaders from the Group of 20 last week to boost the Special Drawing Rights of the International Monetary Fund is like creating "helicopter money for the globe."

"That is pure money creation," German business daily Handelsblatt quoted Stark as saying, indicating that the move could spur inflation.