Tue Aug 10, 2004
By Kyle Peterson

CHICAGO (Reuters) - The dollar slipped to a three-week low against the euro on Tuesday as traders staked out positions in advance of the much awaited Fed decision to hike U.S. interest rates and any new signals on future rate changes.

Markets widely expect the Federal Reserve to issue its second rate hike in four years, raising target borrowing costs by a quarter percentage point to 1.50 percent. But weak U.S. economic data and soaring oil prices have caused investors to question the pace and timing of further dollar-boosting rate hikes.

A Fed statement on the economy due alongside the 2:15 p.m. EDT rate announcement may clarify the outlook. Traders said the euro's lurch higher in New York trade represents concerns in the market that the Fed's assessment of the economy may be less optimistic than it was in June.

"Obviously the Fed is still seen raising interest rates. They have well-telegraphed this move, and failure to go ahead and raise rates today would smack of panic," said Alex Beuzelin, forex market analyst at Ruesch International in Washington D.C.

"The dollar stands to lose if the Federal Reserve signals a more cautious assessment of economic conditions and hints at a scaling back of its rate tightening cycle," he said.

In mid-morning New York trade, the euro was up 0.37 percent at $1.2316 (EUR=: Quote, Profile, Research) . The single currency gained broadly after blasting through buy orders reportedly at $1.2290.

"I would say this is pre-Fed positioning. There's more and more talk that the Fed may soften its statement, so there's some euro buying going on just in case," said Andreas Mann, senior trader at Commerzbank in New York.

The dollar was up 0.05 percent at 110.73 yen (JPY=: Quote, Profile, Research) . Sterling was near flat at $1.8391 (GBP=: Quote, Profile, Research) . The dollar was down 0.34 percent against the Swiss franc (CHF=: Quote, Profile, Research) at 1.2501 francs .

Tuesday's economic data calendar was light. Data showed that U.S. productivity increased more than expected by 2.9 percent in the second quarter.

"It looks like a fairly positive number, but I don't think the market cares at this point," said John Beerling, regional foreign exchange trading desk manager at Wells Fargo in Minneapolis. "I think we are just waiting for the Fed."

Another report from Investor's Business Daily and TechnoMetrica Market Intelligence showed a slight gain in economic optimism in August. The index rose to 57.7 in August from 57.3 in July.

Other recent data have bolstered a gloomy outlook for the U.S. economy. On Friday data showed the U.S. economy added 32,000 jobs in July, about 200,000 fewer than analysts had expected. This sent the dollar more than two cents lower versus the euro during Friday's session.

Such data have caused analysts to reconsider forecasts for more rate hikes this year. The Fed has repeatedly signaled that it would tighten monetary policy at a "measured" pace this year.

Prospects for rate hikes have been key support for the dollar this year as investors weigh the dollar's rising yield appeal against structural problems in the U.S. economy.

High oil prices have been another focus of the market. Crude oil crossed the $45 point for the first time hitting a high of $45.04 a barrel as violence in Iraq disrupted output and exports, compounding fears that tight global supplies may be inadequate to meet demand. Oil traders were also weighing the effect of storm-related precautions taken by Shell in the Gulf of Mexico

On Tuesday, Venezuela's oil minister said that he sees oil prices holding near their 21-year highs for the rest of 2004, as the high-consumption winter period nears.

Rising oil prices have also weakened the yen due to Japan's reliance on oil.

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