Dollar slides on soft Chicago PMI report

NEW YORK, Aug 31 (Reuters) - The dollar slid on Wednesday after a report showed business activity in the U.S. Midwest contracted unexpectedly, for the first time in more than two years.

The Chicago purchasing management index for August came in at 49.2, sharply below market forecasts for a reading of 61.5 and under 50, which denotes a contraction. August's reading was the lowest since April 2003.

The euro last changed hands up 1 percent against the dollar at $1.2343 in midafternoon trade. Before the data, the euro zone single currency had traded around $1.2210. August was the best month for euro/dollar since December.

The dollar fell 0.6 percent against the yen to 110.60 yen. Earlier, the U.S. currency hit a three-week high at 111.78 yen as the Japanese currency struggled with the anticipated impact high oil prices will have on Japan, which imports all the crude oil it uses.

"On balance, (the PMI) is a dollar-negative number because it compounds concerns about the dampening affects of high oil prices on growth and supports the view U.S. interest rates may top out at a lower level than previously anticipated," said Alex Beuzelin, senior market analyst at Ruesch International in Washington.

The dollar has rebounded for most of 2005 on expectations the Federal Reserve will continue its rate hiking campaign, boosting the allure of some short-term dollar denominated assets. Analysts are certainly re-examining their bullish view on the U.S. currency and extent of future rate increases.

On Wednesday, interest rate futures and bond yields tumbled. The implied year-end fed funds rate fell below 4 percent, from around 4.15 percent as recently as Monday. The fed funds rate currently stands at 3.5 percent.

Anthony Santomero, president of the Philadelphia Federal Reserve Bank said on Wednesday that low rates partly reflect low inflation expectations.

The dollar earlier came under slight pressure after data showed the U.S. economy grew slightly less in the second quarter than initially reported.

U.S. gross domestic product, a measure of all goods and services produced within the country, expanded at a revised 3.3 percent annual rate in the second quarter after a 3.8 percent first-quarter rise, according to the Commerce Department.

The Chicago PMI extended the dollar's losses.

The dollar was down 1.3 percent against the Swiss franc to 1.2530 francs, posting its biggest one-day percentage decline since February. That helped the greenback post its worst month against the franc since November.

The Swiss currency firmed after the KOF leading indicator rose to 0.71 in August from a revised July figure of 0.64, brightening the outlook for the Swiss economy.

Sterling gained 1 percent to $1.8037, which helped the pound show its best monthly performance against the dollar since November.

"With the energy market so close to the surface in the markets here, the (Chicago PMI) number just amplified the current thinking that the recent hurricane and the effects on the energy market may have a broader impact than people were thinking," said Ronald Simpson, managing director of global currency analysis with Action Economics in New York.

Oil was once again one of the main drivers of the currency market even as oil futures eased from record highs. Energy experts said the two-year bull run that took oil to $70.85 on Tuesday may not have run its course.

This placed downward pressure on currencies in oil-reliant Asia, which were already reeling from fears of an economic crisis in Indonesia after its currency plunged to a 4-year low against the dollar this week.

Analysts were also assessing the potential damage caused by Hurricane Katrina.

"The hurricane itself will put a drag on overall growth in the economy, even though there will be sectors that will ultimately benefit from what is going to be a massive clean-up and rebuilding effort," HSBC said in a research note.

Estimates have put the cost of the storm at $25 billion. The bank noted that given the extent of the storm's damage to New Orleans and a swath of the U.S. Gulf coast, some of the large European insurance companies could buy dollars and sell either the Swiss franc or euro to cover the cost of those claims. That should underpin the dollar in the near term.

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source: reuters

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