Dollar Extends Losses vs. Yen After Paulson's Statement

The U.S. dollar fell sharply against the yen Wednesday, as investors shunned riskier assets after comments by U.S. Treasury Secretary Henry Paulson heightened concerns about the economy and sparked a sell-off in global equities.

Sterling tumbled to a six-and-a-half year-trough versus the greenback and a record low against the euro after the Bank of England warned the British economy will shrink sharply next year. BoE Governor Mervyn King also bolstered expectations of further aggressive interest rate cuts.

U.S. stocks extended losses after Paulson said he was backing away from buying troubled mortgage assets using the government's $700 billion bailout fund. "This is not the most effective way to use TARP funds,'' he told a news conference, referring to the Troubled Asset Relief Program.

Paulson's comments compounded worries about the global economy, which is facing tough times as a result of the worst financial crisis in decades. The dollar and the yen have performed strongly in the recent environment of extreme risk aversion.

"The yen has gotten significantly stronger because global equity markets are again under pressure. It's a similar trend to what we've been seeing over the past month. It's really a flight to quality,'' said Matt Esteve, a forex trader at Tempus Consulting in Washington.

"Unfortunately, as the markets go down, you'll see the yen continue to strengthen,'' he added.

In midday New York trade, the dollar last traded down over 2 percent at below 96 yen , after falling as low as 94.49 yen, the lowest level since Oct. 28, according to Reuters data.

The yen also soared versus the euro, the pound and the Australian and New Zealand dollars as investors exited high-yielding, riskier currencies.

The euro fell close to 2 percent to near 120 yen, after hitting 118.10 yen.

Sterling Stung

Sterling dropped more than 2 percent against the dollar to $1.4898, according to Reuters data, its weakest level since 2002, after the BoE's King told reporters that the central bank was prepared to cut interest rates even more after a stunning 150 basis point cut last week.

More From CNBC.com

• Recession or Depression? Finding the Trigger ...
• China's Appetite for Treasurys May Diminish
• Signs of China Slowdown Fan Recession Fears
• The Difference Between Good Debt and Bad Debt
• Holiday Sales to Drop 1%
• Treasury Mulls Private Capital Role in TARP: Report
• BoE Signals More Rate Cuts

The BoE's quarterly Inflation Report predicted the UK economy will shrink sharply next year and inflation may fall to just below 1 percent .

Ashraf Laidi, chief FX strategist at CMC Markets U.S., said the selling pressure on sterling was also exacerbated by reports showing unemployment hit a 16-year high and average earnings growth was the weakest in five years.

"If buying the yen was seen as the path of least resistance, then selling the pound has been the more popular trade,'' he said.

Sterling also fell 2.5 percent against the euro, hitting an all-time low of 84.11 pence, according to Reuters data.

For Investors:

• Currencies at a Glance
• Futures and Pre-Market Data
• Credit Spreads and Libor Data

Against a basket of currencies, sterling hit a 12-year low.

The euro fell to a two-week low at $1.2469 against the dollar before rebounding, and last traded up 0.5 percent at $1.2573. Analysts said the currency remained under pressure after data showed euro zone industrial production fell more than expected in September.

Overall, rising risk aversion, a generally weaker tone in equities and global recession fears will likely continue to benefit the greenback, analysts said.

"I continue to look for...an overall risk-averse theme to be the dominant one,'' said Dustin Reid, senior currency strategist at RBS Global Banking & Markets in Chicago. "As such, I have a difficult time seeing a material U.S. dollar decline from here."

Copyright 2008 Reuters. Click for restrictions.