Japanese fears drive dollar down

Korea triggered a similar dollar drop in February

The US dollar has fallen after Japan's prime minister hinted that the country could look elsewhere for its foreign currency reserves.

Junichiro Koizumi's comments weakened the dollar, pushing the euro up 0.5% to a two-month high of $1.3455.

The US's massive deficits are being propped up largely by Asian central banks buying dollars.

Suggestions that South Korea might diversify away from the dollar prompted sharp falls on Wall Street.

Expectations are that the euro, which has been at historic highs, could pick up the slack if the dollar's attraction as the world's reserve currency weakens.

Spreading the load

Thursday's exchange rate shake-up was triggered by testimony from Mr Koizumi to a Japanese parliamentary committee.

"I believe diversification is necessary," he said when asked about the risk of having the country's foreign currency reserves focused on the dollar.

Ministry of Finance officials later denied that he was hinting at an imminent change of policy.

That was enough to reverse some of the 1% fall of the value of the dollar to about 103.7 yen, which had been the immediate market reaction.

Bad news about machinery orders in Japan also took the edge off the yen's rise.

Asian support

But the rapid reaction underscores the jitters now prevalent about the state of the dollar, and the US deficits.

The US sucks in about $2bn a day to fund both a budget gap of some $500bn, and a current account deficit - the difference between what the US's overall income and outgoings - at record proportions.

Most of that funding comes from Asia, with Japan's and China's central banks bearing most of the burden.

By buying dollars, Japan hopes to keep its own currency from rising too fast against a dollar which has been weakening for months.

But several months in the past two years have seen the pace of purchases of government bonds fall back, intensifying fears that the appetite for dollars may yet prove limited.