updated 7/2/2007 4:37:37 PM ET 2007-07-02T20:37:37

The dollar fell to a 26-year low against the British pound Monday ahead of an expected rate hike by the Bank of England later this week.

Major Market Indices

The pound rose to $2.0173 — its highest level versus the dollar since June 1981 — in New York trading before retreating to $2.0165. The dollar also dropped to within a cent of its all-time low versus the euro, as rising global interest rates made the currency less attractive to investors.

The 13-nation euro rose to $1.3637, just shy of its April 27 all-time high of $1.3682, before dipping back to $1.3623.

The Bank of England and European Central Bank meet separately Thursday to discuss interest rates. The BOE is expected to raise its key rate a quarter-point from 5.5 percent, while the ECB is expected tighten monetary policy later this year.

The U.S. Federal Reserve, meanwhile, has left its key rate unchanged at 5.25 percent for the past year.

Higher interest rates, a weapon against inflation, can bolster a currency by giving better returns on fixed-income investments.

The dollar has been especially weak for so many months, it’s difficult to put a finger on a single catalyst for Monday’s losses, said David Solin, a partner at Foreign Exchange Analytics in Essex, Conn.

“What really triggered this sudden realization that the dollar should be sold off?” he said.

Along with this week’s BOE and ECB meetings, traders eyed firmer U.S. bond yields and thin markets ahead of the July 4 holiday, Solin said.

The British pound shook off terrorism fears Monday following last week’s two failed car bombings in London and the attempted weekend attack on the airport in Glasgow, Scotland.

The euro climbed after German industry group VDMA reported that new orders for the country’s machinery industry rose by 18 percent in May from a year earlier. Germany is the euro zone’s largest economy.

In the U.S., a report on June manufacturing activity indicated easing inflation.

The Institute for Supply Management’s manufacturing index came in at 56.0, slightly beating expectations and showing stronger expansion over May’s reading of 55.0. The report also showed a drop in its prices paid index, suggesting inflation pressure eased last month.

The dollar slipped against the yen after a Bank of Japan business confidence survey supported predictions that the country’s central bank may raise interest rates as early as August.

The dollar bought 122.32 yen, down from 123.14 yen late Friday. In other trading, the dollar bought 1.0562 Canadian dollars, down from 1.0626, and 1.2103 Swiss francs, dropping from 1.2219.

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