NEW YORK (AFX) -- The dollar fell Thursday, hitting a six-week low against the euro and an almost two-week low against the Japanese yen as a benign inflation report boosted expectations that the Federal Reserve would soon stop raising interest rates.
The U.S. consumer price index rose 0.1% in February, the Labor Department said. The increase matched Wall Street's expectations. The core CPI, meanwhile, increased 0.1%, a tick lower than the 0.2% gain expected by economists polled by MarketWatch.
'The knee-jerk reaction [of the market] is to the CPI data,' said Lara Rhame, a currency strategist at Credit Suisse First Boston. 'The core number was weaker-than-consensus. I think that's the key thing that the markets are reacting to.'
In late New York trading, the euro rose to $1.2189, the highest level since the end of January, before paring gains to trade at $1.2179, up 0.9% from late Wednesday.
The dollar last changed hands at 116.81 yen, down 0.6%, having earlier touched 116.74 yen, the lowest level since March 6.
Rate outlook
The financial markets shifted expectations for the Federal Reserve's monetary policy significantly Thursday, partly triggered by the tame CPI data, analysts said.
Markets are now expecting the FOMC to raise interest rates by a quarter of a percentage point to 4.75% later this month. After that, the outlook is hazy. The odds of a rate hike in May fell from 86% Wednesday to 65% Thursday. The odds were quoted at 100% Monday.
Futures markets now expect the federal funds rate to peak at 5% in May, rather than at 5.25% in June as expected just four days ago. The Fed has increased borrowing costs 14 times since June 2004, to the current 4.5%
Ronald Simpson, a currency analyst at research firm Action Economics, said 'the move that we've seen [today] is as much a function of market positioning as the data.'
'We're doing some correction of overshooting,' said Naomi Fink, a currency analyst at BNP Paribas. 'There has been minor expectation of a Fed hike to 5.25%...it might be scaling back a little bit.'
The dollar extended losses after a report showed manufacturing activity in the Philadelphia region showed a slower pace of growth in March, and a steady reduction in inflation pressures.
Philly Fed business activity index slipped to 12.3 in March from 15.4 in February. Economists expected the index to fall to 13.8.
Separately, the Commerce Department said the country's pace of constructing new homes slowed in February after soaring to a 12-year high in January.
Housing starts fell 7.9% in February to a seasonally adjusted annual rate of 2.12 million housing starts.
The level of housing starts in February was higher than economist expectations, according to a survey conducted by MarketWatch. Economists had forecast starts would fall to 2.04 million units from the initial estimate of 2.28 million units in January. .
Also, the Labor Department said new applications for state unemployment benefits rose by 5,000 to 309,000 in the week ending March 11, the highest level since December. Economists polled by MarketWatch expected claims to fall to about 300,000.
Yen, sterling, francs
Overnight, the yen was on the defensive after Bank of Japan Governor Toshihiko Fukui reaffirmed that accommodative monetary policy will remain. But the yen's decline was short-lived.
Fukui hinted that it was too early to consider lifting interest rates, but his language was short of a pledge not to abandon the low-rate regime.
'Interest rates will be kept at zero for the time being,' Fukui told a financial affairs committee of the Upper House of the Diet, or parliament. 'And we see a high probability that we'll be able to continue providing an accommodative environment with relatively low interest rates after that.'
His comments came across 'as a bit more dovish, which weighed on the yen slightly,' said Steve Barrow, chief currency strategist at Bear Stearns, in a note.
Elsewhere, the British pound edged higher as February retail sales in the U.K. rose 0.5% from January, or up 2.1% for the year. The climb came after January's 1.6% monthly decline.
The pound was at $1.7573, up 0.6% from late Wednesday.
On Thursday, the Swiss National Bank, as expected, raised its three-month Libor range to 1.25% from 1%.
The central bank expects oil to moderate somewhat in 2006, and said economic development was in line with expectations. 'Provided that the economy continues to perform as expected, the National Bank will further pursue the gradual adjustment of its monetary policy,' it added.
The dollar was last down 0.4% at 1.2896 Swiss francs. This story was supplied by MarketWatch. For further information see www.marketwatch.com.