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The dollar’s decline paused on Wednesday as profits were taken after the US currency hit a 26-year low against the pound, while the euro crept ever closer to record levels.

Sterling moved as high as $2.0133 against the dollar before profit-taking, particularly in the carry trade cross between the UK currency and Japan’s yen, pulled the pound lower against most other currencies.

The pound’s initial move higher to levels not seen against the dollar since June 1981, came shortly after minutes from the Bank of England’s last policy meeting reinforced expectations of a 25-point interest rate increase to 5.5 per cent next month after two members of the monetary policy committee voted for a rise this month.

Hawkish data continued to pile up. After Tuesday’s shock rise in inflation to 3.1 per cent, pressure on the BoE intensified after the Office for National Statistics reported average earnings rose 4.6 per cent in the three months to the end of February – above the 4.5 per cent the central bank considers consistent with stable inflation.

With inflation in the US appearing relatively benign, traders and economists considered how long the dollar was likely to remain at such subdued levels.

“In our view sterling is likely to remain well supported,” said David Bloom at HSBC.

He added: “The powerful trend has been occurring since early March when the market became worried about US growth, hence $2 is probably more a function of a weak US growth and inflation mix than a specific sterling story.”

In late New York trade the pound had retreated to $2.0065, a fraction higher on the session. Against the yen, sterling pulled back 0.1 per cent to Y238.24.

Similarly the euro pulled back as profits were taken after the strong gains of recent days, but analysts remained bullish about the near-term prospects for the single currency.

Eurozone data and the European Central Bank have indicated rates in the 13-nation bloc, having been held this month, will be lifted again by 25 basis points to 4 per cent in June.

Brian Garvey, at State Street, said the euro’s record $1.3670 hit in the last week in December 2004, was largely a function of low liquidity and rumour-driven market conditions that kept the single currency above $1.36 for only four days.

”$1.36 today is largely a function of the cyclical divergence between the US and eurozone economies, rather than central bank rumours, ill-timed comments by policymakers, or illiquid market conditions,” he said.

He added: “It is for this reason we believe the current move to $1.36 and beyond will prove more sustainable.”

Although the euro hit a fresh two-year high of $1.3616 against the dollar, profit-taking drove the single currency back to $1.3590, leaving it up 0.2 per cent on the day.

The yen was the biggest beneficiary of profit-taking, as funds unwound some of their carry trade positions to take advantage of the strong gains for high-yielding currencies in recent sessions.

Against the euro, the Japanese currency was nearly unchanged at Y161.35. The dollar fell 0.2 per cent to Y118.75.

The New Zealand dollar hit a 22-year high against the US dollar as the view that NZ rates – already at 7.5 per cent – still had further to rise in spite of softer-than-expected inflation data.

The kiwi climbed as high as $0.7492, but ended the session 0.4 per cent higher at $0.7475. Against the yen, another favoured carry trade cross, the kiwi rose 0.3 per cent to Y88.80.

The Australian dollar lost ground on profit-taking after closing in on 17-year highs against the US dollar. The Aussie was a touch firmer at $0.83.70. while shedding 0.1 per cent against the yen to Y99.38.

Sterling surged through $2 on Tuesday as expectations of widening interest rate differentials between the US and UK followed inflation data from both countries.

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