(Recasts lead paragraph, adds quote, data, updates prices)
By Gertrude Chavez-Dreyfuss
NEW YORK, Feb 21 (Reuters) - The dollar fell to two-week
lows on Thursday after data showing a much
sharper-than-expected contraction in U.S. Mid-Atlantic factory
activity this month made investors brace for more Federal
Reserve rate cuts.
Futures markets have almost fully priced in another half
percentage point rate reduction at the Fed's March meeting, up
from an 82 percent chance seen before the sharp fall in the
Philadelphia Federal Reserve's business index . <FEDWATCH>
More U.S. rate cuts would further erode the dollar's appeal
to global investors, particularly when central banks in Europe
and Australia are keeping rates steady or raising them.
"(The Philadephia Fed survey) is a big black eye for dollar
bulls. It's really starting to confirm the notion that the U.S.
economy is slowing considerably," said Boris Schlossberg,
senior currency strategist, at DailyFX.com in New York.
The euro rose to two-week highs against dollar at $1.4800,
according to Reuters data, but traded back down to $1.4788
<EUR=>, still up half a percent on the day. The dollar also
dropped to two-week lows against a basket of major currencies
at 75.686 <.DXY>.
Against the yen, the dollar fell 0.4 percent to 107.60 yen
<JPY=>.
Minutes from the Fed's last policy meeting showed on
Wednesday that policy makers are worried about still slower
U.S. growth even after their series of aggressive rate cuts.
The Fed also lowered its U.S. growth forecast for 2008.
The Philadelphia Fed business activity index's decline to
minus-24 in February -- its worst reading since 2001 -- seemed
to support that view. It also confounded economists who had
expected a more modest reading of minus 11.
Readings below zero represent contraction in the industrial
sector, which many believe could now be in recession. National
data has been less dire, suggesting some regions are suffering
more acutely from the housing slump than others.
"The Fed .... was basically saying that rate cuts will
continue for the foreseeable future. They're seeing a more
severe contraction than first meets the eye," Schlossberg
said.
ECB RATE CUT EXPECTATIONS FADE
In contrast to Fed expectations, investors are scaling back
expectations for European Central Bank rate cuts this year as
French inflation rose to its fastest annual pace in at least 11
years,
Futures market are now pricing in only a 1-in-4 chance of a
rate cut from 4 percent by June <FEIM8>. Just last week, a June
rate cut had been fully priced in.
That should keep the pressure on the dollar, as investors
have more incentive to hold higher-yielding euro-denominated
debt over U.S. debt.
The euro also rose to five-week highs against the yen near
159.60 yen <EURJPY=> but last traded just slightly higher at
159.15.
Sterling, meanwhile, gained 0.9 percent to $1.9591 <GBP=>
thanks to an unexpectedly strong retail sales report which
helped ease concerns about the health of the UK economy.
Soaring commodity prices are also on traders' radar
screens. Gold and platinum hit historic highs, while silver hit
a 27-year high, extending their recent rallies.
U.S. crude oil held near $100 a barrel <CLc1>, having hit a
record high above $101 on Wednesday.
"If oil continues its upward trajectory, that will have
people concerned about the impact of high oil prices on the
U.S. economy and that could be negative for the dollar," said
Shane Enright, a currency strategist, at CIBC World Markets in
Toronto.
(Additional reporting by Steven C. Johnson; Editing by
Chizu Nomiyama)
