Dollar sets fresh lows as market dares Fed to cut

LONDON (Reuters) - The dollar hit a record low against the euro, the Swiss franc and a basket of currencies on Thursday, as the market upped the ante on the Federal Reserve to deliver an interest rate cut next month.

Adding to downward pressure on the dollar was a recovery in equity markets and a slight pick up in risk appetite, which made investors more willing to put on riskier trades in high-yielding or emerging market currencies.

The more risk-friendly mood also hit the yen -- a favorite source of cheap funding for the carry trades. The Japanese currency eased from the previous day's 2-1/2 year peaks versus the dollar, while high-yielding Australia and New Zealand units -- top carry targets -- gained broadly.

With the United States marking Thanksgiving holiday on Thursday and Japan shut on Friday, volumes were likely to remain subdued into the end of the week, potentially exacerbating market volatility.

"We are looking for continued dollar weakness and would not be surprised to see euro break $1.50 within weeks rather than months," said Teis Knuthsen, head of FX research at Danske Markets in Copenhagen.

"Primarily it's still the relative economic development between the U.S. versus the rest of the world, combined with the ongoing financial crisis which is heavily concentrated in the U.S.," he added.

The euro hit a record high of $1.4873 according to Reuters data on Thursday, bringing its year-to-date gains to around 12.5 percent. It also set fresh all-time highs against the ECB's trade-weighted basket of 24 currencies at 111.17.

The dollar fell to a fresh historic trough of 1.1007 Swiss francs, before recovering a little to trade at 1.1022 francs by 3:11 a.m. EST.

The dollar index, which measures the dollar's value against a basket of major currencies, hit a record low of 74.916 (.DXY: Quote, Profile, Research).

Expectations for further U.S. rate cuts were reinforced on Tuesday by the Fed's projection that economic growth will slow next year, even though the central bank adopted a reasonably hawkish tone and said that October's cut was a "close call".

U.S. short-term interest rate futures are pricing in a 25 basis point Fed cut to 4.25 percent on December 11, and are even giving a small chance of a larger 50 basis point move.

CAUTIOUS RETURN TO RISK

However the dollar gained half a percent against the yen, to 108.87 yen, pulling away from the 2-1/2 year low of 108.23 yen hit according to Reuters data on Wednesday.

Buying by Japanese institutional investors helped boost the dollar versus the yen, traders said.

The euro rose 0.5 percent to 161.64 yen, while the Australian dollar recovered from a two-month low against the U.S. currency.

European stocks opened higher on Thursday (.FTEU3: Quote, Profile, Research), after Tokyo's bourse (.N225: Quote, Profile, Research) closed up despite earlier setting 16-month lows.

Nonetheless, analysts advised caution, saying more bad news from the financial sector's exposure to the global credit crunch could be just round the corner.

"Both financial market and macroeconomic risk are likely to continue to dominate G10 FX," Societe Generale said in a research note.

"Given this, we continue to avoid building long exposure to either the dollar or indeed the riskier higher yielding currencies, such as Australia and New Zealand dollars."

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