Foreign inflows drive dollar

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Foreign iinvestors poured a record $101.9bn into US assets in September, according to Treasury data that eased market concerns about funding the US current account deficit and propelled the dollar towards two-year highs against the euro and sterling.

US inflows were dominated by $93.4bn of inflows into bonds, but overseas investors put $24.6bn into US equities the largest monthly net inflow since February 2000, just ahead of the bursting of the stock market bubble.

The flow into stocks was encouraging since it indicated a broadening of investor interest that should support future inflows and leave the greenback less dependent on demand for bonds.

“If this is an indication of things to come, foreign demand for US equities may be a fresh source of dollar demand that could reinforce the current rally into next year,” said Michael Woolfolk, currency strategist at Bank of New York.

The dollar pushed the euro back to $1.1646, virtually matching the two-year highs reached on Tuesday, and reached a two-year peak at $1.7138 against sterling. Sterling's weakness was also aided by lower inflation projections from the Bank of England on Wednesday, which increased the chance of a cut in UK interest rates.

The pound has been on a downward trend since the Bank made a quarter-point cut in its official rate in August to 4.5 per cent, on expectations of a period of unchanged UK rates and against expectations of interest rate rises in the US and the eurozone.

Eurozone annual inflation was 2.5 per cent in October, down from September's 2.6 per cent, according to data released on Wednesday by Eurostat, the eurozone official statistics agency.

But stronger-than-expected economic growth in France and Germany in the third quarter has led to expectations that the European Central Bank will raise its main lending rate, for the first time in five years, to 2.25 per cent when its governing council meets on December 1.

The ECB has kept the rate unchanged at 2 per cent since June 2003.

Meanwhile, US currency traders regard the portfolio data as a gauge of dollar appetite and, as a rule of thumb, look for net inflows to cover the US trade deficit for the month, which in September reached a record $66.1bn.

“These figures are just so off the scale,” said Tony Norfield, global head of FX strategy at ABN Amro. “For the dollar it is not about how big is the deficit, it's about how easily it is being financed.”

The US portfolio data were regarded as particularly strong because the inflows largely came from private investors. This indicates a stronger vote of market confidence in US assets than if the money had come from official institutions such as foreign central banks.

Asian central banks, in particular, have been large buyers of US bonds in recent years as they recycled their dollar surpluses.

In September, however, foreign central banks accounted for just $4.3bn of inflows. Overseas central banks' share of inflows has fallen to just 12.7 per cent of the total this year, from 29 per cent in 2004.

Additional reporting by Steve Johnson in London

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