Dollar poised for biggest weekly gain in 16 yrs

The dollar hovered near a one-year peak against a basket of major currencies on Friday.

The dollar hovered near a one-year peak against a basket of major currencies on Friday as banks and financial institutions have scrambled to buy the US currency after being locked out of frozen money markets.

The dollar held gains scored versus the euro the previous day after European Central Bank President Jean-Claude Trichet said inflation risks have eased, bolstering expectations the ECB will follow other major central banks in cutting rates.

So far on the week, the dollar has soared 4 per cent against a basket of six major currencies 8212; poised for its biggest weekly rise in 16 years.

Traders and analysts said the severe squeeze in interbank lending 8212; which has driven three-month dollar LIBOR rates up a full per centage point in two weeks to more than double the Federal Reserve8217;s 2 per cent rate target 8212; was a major factor behind the dollar8217;s gains.

8220;It8217;s all about fear, the next shoe to drop, and it looks like it8217;s going to be in Europe,8221; said a senior currency trader at a US investment bank in Hong Kong. 8220;Europeans are paying a dear price to fund themselves in dollars, and that8217;s behind the dollar8217;s rise.8221;

The trader said that if money market conditions do not begin to thaw after the expected passage of the 700 billion bank bailout plan in the US House of Representatives on Friday, then market players will look for coordinated central bank rate cuts.

The crisis of confidence among banks after the demise of Lehman Brothers and troubles at other major financial firms has caused interbank lending to all but dry up, leaving many players desperate for dollar funding wherever they can get it.

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8220;There is the added element of dollar buying, regardless of the level, by people facing funding strains,8221; said a senior trader for a major Japanese trading house.

Societe Generale8217;s FX sales desk told clients that 8220;the underlying market theme is the dollar funding story.8221;

The euro was little changed from late US trade at 1.3830, recovering from an initial dip near the 13-month trough of 1.3747 struck on trading platform EBS on Thursday.

The single currency dipped 0.1 per cent to 145.40 yen after sliding to a two-year trough of 144.56 yen at one point. The dollar inched down 0.2 per cent to 105.10 yen

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The dollar index, which gauges its performance against a basket of six major currencies, dropped 0.2 per cent to 80.375 after reaching a one-year peak of 80.794 the previous day.

Trichet and other officials rejected any need for a European rescue fund for banks suffering from the credit crisis as French President Nicolas Sarkozy prepared to host a summit on the crisis in Paris.

A slew of economic data this week showing the US economy has likely fallen into a full-blown recession has done little to take the wind out of the dollar8217;s rise, even as the Fed is seen likely to cut rates as well this month.

While the dollar has powered higher, so has the yen as the crisis has prompted market players to still unwind stale positions favouring carry trades 8212; using the low-yielding Japanese currency to buy higher-yielding currencies.

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The euro tumbled to a two-year low against the yen, while the Australian dollar slid near a three-year trough touched the previous day.

The Fed8217;s broad dollar trade-weighted index rose 2 per cent in September, but the Bank of Japan8217;s trade-weighted index showed the yen gained 4.4 per cent the same month.