TOKYO, Oct 23 - European currencies, led by sterling, were firmer on Thursday as a global stock market sell-off this week prompted the market to favour currencies with higher interest rates and weighed on the dollar and yen. The dollar was roundly beaten and struggled within one percent of three-year lows against the yen. But its decline against the Japanese currency halted as the Tokyo stock market's Nikkei average <.N225> fell more than four percent, twice as much as Wednesday's losses in the Dow Industrials <.DJI>. "The dollar is bearish all around, but you really can't buy the yen either if you look at the state of Japanese stocks right now," said Hideaki Furumaya, head of the interbank desk at Trust & Custody Services Bank. "With stock markets worldwide apparently topping out, it is quite normal to see investors seek refuge in higher yielding currencies," he said. Sterling rose to five-year highs for the second day running, rising about a half cent on the day at one point to a peak of around $1.6965 .
The euro was up marginally on the day at $1.1817/22 as of 0325 GMT. Although interest rates on the euro itself are not particularly high, the single currency benefited from its vast liquidity which other higher yielding currencies like sterling, the Australian dollar and the Canadian dollar did not have, traders said. The benchmark U.S. federal funds rate is about one percent and the overnight call rate in the Japanese market is below 0.1 percent, while the European Central Bank's (ECB) refinancing rate is 2.0 percent and the Bank of England (BOE) rate is 3.5 percent. The market's focus on higher rates had been ignited by minutes of the BOE's October rate-setting meeting released on Wednesday which showed that four of the nine-member Monetary Policy Committee voted for an immediate rate hike. Higher yields also attracted buying in the Australian dollar and the Canadian dollar, which tested Wednesday's six-year highs and 10-year highs respectively. Traders said the market was keeping a close eye on the ECB's governing council meeting later on Thursday, although no policy change was expected for now.
STRONG DOLLAR POLICY
The dollar stood at 109.00/04 yen , virtually unchanged from Wednesday's late New York levels, although it was within a yen of three-year lows around 108.25 set two weeks ago. A big drop in Japanese stocks, coupled with economic indicators that pointed to an economic contraction in the July-September quarter, undermined the yen, traders said. The Japanese Ministry of Economy, Trade and Industry said its all-industries activity index -- widely regarded as a close proxy to gross domestic product (GDP) -- rose only 0.3 percent in August from the previous month. The rise was smaller than a consensus forecast of a 0.5 percent gain and comes after a 1.5 percent drop in July. "We had a weak reading in July and the bounce in August was not that strong. This means July-September GDP figures won't be too strong either," said Shuji Shirota, economist at Dresdner Kleinwort Wasserstein, who forecast a contraction of 0.6 percent in the third quarter GDP. Still, the yen could resume its ascent against the dollar if the market puts its focus back on political aspects of global currency arrangements. In a sign that Washington did not approve of Asian countries' policies of trying to keep their currencies from rising against the dollar, Snow said he planned to press his case for a more flexible Chinese currency in Mexico this weekend. Snow is to hold a bilateral discussion with his Chinese counterpart in Morelia, Mexico, on the fringes of a gathering of finance chiefs from the Group of 20 economies.//