Dollar weakens as housing prices, confidence fall

NEW YORK (Reuters) - The dollar retreated on Tuesday as a plunge in consumer confidence and declining home prices raised doubts about the Federal Reserve’s ability to hike interest rates to stem inflation.

The dollar struggled as the Fed began a two-day monetary policy meeting on Tuesday, with analysts expecting the U.S. central bank to hold interest rates steady at 2 percent. But traders will pore over the Fed’s accompanying statement for clues about possible hikes later in the year.

Analysts said Tuesday’s data complicated matters for the Fed as it tries to prevent the economy from slipping into recession while grappling with rapidly rising food and energy prices.

“The real domestic data in the U.S. is really bad and this has pushed the dollar lower ... but still the Fed is stuck because inflation expectations have risen,” said Benedikt Germanier, chief currency strategist in the U.S. at UBS AG in Stamford, Connecticut.

“The real economy would demand that the Fed cuts interest rates right now, but it’s not that easy especially with rising inflation pressures, which were caused in part by higher energy prices and a weak dollar,” he added.

The euro earlier hit a session high of $1.5621 after data showed high prices sapped Americans’ confidence in June and pushed expectations of future prosperity to an all-time low. Meanwhile, the headline consumer confidence number sank to a 16-year low.

By late afternoon trading, the euro was still up 0.3 percent at $1.5569. The dollar fell slightly to 107.75 yen from sessions lows at 107.37.

The dollar fell 0.4 percent to 1.0410 Swiss francs, with the franc benefiting from market talk that Swiss bank UBS UBSN.VX was a takeover target for HSBC HSBA.L.

Earlier on Tuesday, the S&P/Case-Shiller house price index showed prices in 20 major metropolitan areas declined 15.3 percent in the year to April. Germanier said UBS expects another 10 percent decline.

At the same time, profits at U.S. S&P 500-listed companies were expected to fall by an average of 10.2 percent in the second quarter, according to Thomson Reuters data, compared with an earlier estimate of a 9.6 percent drop.

“Ongoing downward pressure on housing prices and equity markets is operating to pound household net worth lower in the second quarter of 2008,” said Brian Bethune, chief U.S. financial economist at Global Insight in Lexington, Massachusetts.

He also cites “mounting downside risks to consumer spending in the second half of 2008 despite the recent report of solid non-auto retail sales and the anticipated boost from the tax rebates.”

Analysts also said the U.S. economy’s continued weakness should ease markets’ expectations for rate increases this year.

U.S. short-term interest rate futures trimmed the chances of a rate hike in August to 70 percent from 74 percent after the confidence data, and analysts said that could slide further if the economy continues to show weakness.

If the Fed uses more neutral language on the balance of risks between inflation and growth in its post-meeting policy statement on Wednesday, dollar losses will accelerate, according to Boris Schlossberg, senior currency strategist at in New York.

UBS’ Germanier, on the other hand, believes the Fed will “cut back on its hawkish rhetoric” which should weigh on the dollar’s outlook. He still sees the euro hitting $1.60 against the dollar in one month.

Additional reporting by Steven C. Johnson; editing by Gary Crosse;