Fundamental, technical analysis 3*: The dollar strengthened most.

By Jamie McGee and Michael J. Moore

 

Dec. 19 (Bloomberg) -- The dollar strengthened the most against the euro in almost two months as traders said the decline was too fast to be sustained after the Federal Reserve lowered the target lending rate to near zero this week.

 

The euro also weakened after the European Commission said the region may suffer a "substantial" effect from the financial crisis next year. The yen traded near a 13-year high against the dollar even after the Bank of Japan lowered its benchmark interest rate to 0.1 percent.

 

"This was the most concentrated, rapid rally in the euro since its creation," said Robert Sinche, head of global currency strategy at Bank of America Corp. in New York. "The market got a little ahead of itself in the short run. We are getting a healthy correction now."

 

The dollar climbed 2.5 percent to $1.3898 versus the euro at 3:53 p.m. in New York, from $1.4240 yesterday, when it slumped to a 12-week low of $1.4719. It gained as much as 3 percent, the biggest intraday increase since Oct. 24. The euro fell 2.8 percent to 123.88 yen from 127.44. The dollar traded at 89.12 yen, compared with 89.43. It dropped to 87.14 yen two days ago, the lowest level since 1995.

 

The U.S. currency declined 2.9 percent against the euro on Dec. 17, the biggest drop since the 15-nation currency's 1999 debut. The Fed lowered its target lending rate a day earlier to a range of zero to 0.25 percent. It reiterated plans to purchase agency debt and mortgage-backed securities and said it will study buying Treasuries.

 

Relative Strength

 

The nine-day relative strength index of the dollar versus the euro, which measures the momentum of gains and losses over time, was at 21.44 yesterday. Readings below 30 and above 70 signal a change in direction maybe imminent.

 

"This is not a fundamentally driven move in the euro," said Lutz Karpowitz

, a Frankfurt-based currency strategist at Commerzbank AG. "We have very low liquidity right now, and volatility is very high."

 

Implied volatility on one-month euro-dollar options averaged 23.2375 this week, about double the year-to-date average.

 

Ukraine's currency jumped 10 percent to 8.2750 against the dollar as the central bank increased its refinancing rate for the second time in two days. The bank raised the rate to 22 percent from 18 percent after boosting it by one percentage point yesterday, when the currency weakened to a record of 9.78.

 

Real's Rally

 

Brazil's real gained the most against the dollar among the 16 major currencies tracked by Bloomberg today, climbing 3.1 percent to 2.3556, on speculation the yield advantage of local fixed-income assets will continue to attract foreign investors. The central bank held the benchmark Selic lending rate at 13.75 percent on Dec. 10.

 

The euro slid against the dollar today, paring its weekly gain to 4.1 percent, after the European Commission said in a report there may be a "sharp" decline in regional economic growth next year.

 

European Central Bank President Jean-Claude Trichet  signaled on Dec. 15 it may pause in reducing borrowing costs at its meeting in January.

 

"The global nature of the current crisis, and increasingly linked global macro cycles, suggest the ECB needs to follow the Fed on the move lower," wrote

 

Brian Kim, currency strategist at UBS AG in Stamford, Connecticut, in a research note today. The euro will fall to $1.25 in three months, he said.

 

Yen's Gain

 

The yen gained 26 percent against the dollar this year, the most since 1987, as more than $1 trillion of credit-market losses and a global economic slowdown encouraged Japanese investors to unwind overseas investments and bring money home. Japan's currency appreciated 1.9 percent this week in its seventh straight advance, the longest rally in four years.

 

Honda Motor Co. may shift research and development out of Japan and increase overseas manufacturing if the yen strengthens further, President Takeo Fukui said in an interview with journalists today.

 

Finance Minister Shoichi Nakagawa  said this week at a news conference that he has "the means" to limit the yen's rally. Central banks buy or sell currencies when they seek to influence exchange rates.

 

The yen will further strengthen against the dollar into the first quarter of 2009, according to  Dustin Reid,  director of currency strategy at RBS Global Banking & Markets in Chicago.

 

"The yen will be seen as the ultimate safe-haven currency," Reid said. "The market eventually will push the dollar-yen low enough to test the Japanese government, Bank of Japan or Ministry of Finance, to test their mettle."

 

Japan's Interventions

 

The last time Japan intervened on its own, it sold a record 20.4 trillion yen in 2003 and 14.8 trillion yen in the first quarter of 2004, when the yen strengthened to 103.42 per dollar. Japan hasn't bought yen since 1998, when it spent 3.05 trillion yen as the currency reached a low of 147.66.

 

The BOJ said today it will raise monthly government bond purchases to 1.4 trillion yen ($15.7 billion) from 1.2 trillion yen to increase liquidity in the financial system. The reduction in the overnight lending rate was predicted by futures traders after the Fed slashed its target rate this week.