No traction for dollar after Fed rate expectations collapse

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[February 04, 2016] By Patrick Graham

LONDON (Reuters) - The dollar was back on the defensive in morning trade in Europe after a collapse in expectations of a further rise in U.S. interest rates this year drove its biggest daily fall in over two months on Wednesday.

Against a basket of currencies, the greenback fell another 0.6 percent to 96.735, having earlier hit its lowest since early November. The euro hit a 3-1/2 month high of $1.1192, extending its gains from the dollar's sell-off a day earlier.

The triggers then were a weak batch of U.S. sentiment data and New York Fed President William Dudley's warning that a weakening outlook for the global economy would have to be taken into account for upcoming rate decisions.

European Central Bank President Mario Draghi's repeated assertion that the bank would not hesitate to do what was necessary to get inflation back to its roughly 2 percent target did little to weaken euro buying.

"The dollar is on its knees," said Richard Benson, head of portfolio management at currency fund Millennium.

"This morning I think it's just model flow on a lot of technical breaks yesterday. Probably we will now have some stability ahead of U.S. payrolls tomorrow."

Against the yen, the dollar has now given up all the gains inspired by a shock cut in Japanese interest rates last Friday. It traded 0.1 percent weaker at 117.77 yen.

The day's big set-piece was the Bank of England's "Super Thursday" cocktail of a monthly policy decision, meeting minutes and quarterly inflation report. A trimming of growth forecasts and policymaker Ian McCafferty abandoning his vote for a rise in interest rates took the shine off a bullish performance for sterling this week.

The pound handed back almost all of its gains against the dollar on the day to trade at $1.4625. It was down 0.6 percent against the euro at 76.55 pence, hitting two-week lows.

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Helped by the dollar sell-off, sterling has bounced 5 cents in the past two weeks as the UK government made progress in talks with Brussels over a new pact with which to fight a referendum on a Brexit from the European Union.

But perceived risks from the vote are still high. Goldman Sachs warned in a note overnight that sterling could fall by as much as 15-20 percent if, as some polls suggest, Britons vote to leave the EU and inflows of foreign investment halt in response.

Expectations for any rise in UK interest rates have also now all but collapsed for the next two years, a quarter point rise in rates now only fully priced in for 2018, although Carney did say the bank believed the next move would be up. <SONIA>

"The Inflation Report ticks all the boxes on the dovish side and with McCafferty changing his call, we can expect more sterling weakness," said John Hardy, head of currency strategy at Saxo Bank.

(Editing by Catherine Evans)

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