Dollar, yen gain as investors turn risk averse

LONDON (AFP) - The dollar and the yen rose yesterday as a new bout of risk aversion gripped global financial markets owing to renewed concerns about the impact of problems in the US subprime mortgage sector.

In late European trade, the euro slipped to 1.3783 dollars, from 1.3796 dollars in New York late on Wednesday.

The dollar appeared to be benefiting from its status as a safe haven at times of financial instability, while the yen was boosted by unravelling of the high-risk "carry trade."

The carry trade is when investors borrow currency in countries with low interest rates, such as Japan, before selling it to buy assets in countries with higher interest rates, such as Britain, Australia or New Zealand.

With global stock markets falling and the ECB announcing a record injection into the eurozone banking sector because of "tensions" on the money market, investors sought to reduce their exposure to risk.

"Under such circumstances the yen will strengthen as market volatility increases," said analyst Derek Halpenny and the Bank of Tokyo-Mitsubishi.

The downturn in global stock markets began early in the day in Europe when French banking group BNP Paribas announced it had suspended three funds exposed to troubles in the US sub-prime mortgage sector.

Traders even cited vague rumours of an emergency rate cut in the US, although this is considered very unlikely.

"This is of course a highly unlikely move, but the fact that such a rumour is circulating at all is significant," said analyst Martin Slaney of GFT Global Markets.

"A cut in US rates in the September FOMC (Federal Reserve) meeting is without doubt back on the cards."

Sub-prime loans are made to borrowers with a weak credit history, while the US sub-prime mortgage crisis has sparked mounting fears that weakness in the American housing sector could infect the world economy.

Elsewhere yesterday, the market reacted cautiously to a report that China might dump the dollar, dealers said.

Dealers were weighing a British newspaper report claiming that China's government might "liquidate" its large holdings of US assets if Washington imposes threatened trade sanctions on Beijing.

Britain's Daily Telegraph newspaper reported that Chinese Communist Party officials had hinted Beijing might use its 1.33 trillion dollars of foreign reserves "as a political weapon" to deter the US Congress from taking action.

President George W. Bush said China would be "foolhardy" to attempt such a move, while US Treasury Secretary Henry Paulson said the report was "absurd."