Rebounding dollar sends euro, sterling to 2 1/2-year lows

Gains in the dollar after the Federal Reserve sounded cautious on more rate cuts sent the euro to a 26-month low on Thursday, as investors decided a lengthy U.S. easing cycle was unlikely.

In a widely expected move, the U.S. central bank cut rates on Wednesday for the first time since the financial crisis, in response to the growing risk of higher import tariffs and a slowdown in the world's major economies. But it also signalled that the quarter point cut may not be the start of a lengthy campaign to shore up the economy.

"It's not the beginning of a long series of rate cuts," Fed Chairman Jerome Powell said after the Fed's decision, although he added, "I didn't say it's just one rate cut."

The Fed's less dovish than expected message triggered a rebound in the dollar, sending the dollar index to a 26-month high of 98.93 on Thursday.

The euro weakened to a 26-month low of $1.1034 and sterling touched a 30-month low of $1.2087.

However, both the euro and the pound were gripped by their own issues.

"You want to stay short euro and sell the rallies," said Stephen Gally, European head of forex strategy at BMO Capital Markets.

Data from the Commodity Futures Trading Commission shows that hedge funds have been doing just that. Short euro positions increased to $5.44 billion in the week to July 26.

Investors expect the European Central Bank to take a more aggressive stance on monetary policy easing than the Fed, which would dampen appetite for the common currency. Fears that Britain may exit the European Union on Oct. 31 without transitional trade agreements in place hurt sterling and the euro.

"With growth slowing below potential and inflation already well below target, there is a strong case for the ECB to act as soon as possible," said Lee Hardman, currency strategist at MUFG.

"The increasing likelihood of a 'no-deal' Brexit and lack of progress in recent U.S.-China trade talks highlight that the outlook for the euro zone economy could yet be hit by more negative shocks heading into year end," Hardman said. "In these circumstances, the euro remains vulnerable to further weakness."

The euro was last down 0.3% at $1.1037. The pound was lower by 0.2% against the euro at 91.29 pence.

Britain's deputy finance minister, Rishi Sunak, said the UK wants a Brexit deal, but "we must have the firmness to leave (the EU) if necessary without a deal."

Investors and analysts expect sterling to decline further as more headlines emphasize the growing probability Britain will quit the European Union without trade agreements on Oct. 31.

Sentiment for sterling has weakened since Britain's new prime minister, Boris Johnson, packed his cabinet with Brexit supporters last month.

Traders will be watching the Bank of England monetary policy announcement later on Thursday to see whether it will respond to the growing probability of a no-deal Brexit. The BoE is widely expected to keep its benchmark interest rate unchanged at 0.75%.

Elsewhere, the Japanese yen fell to a three-month low of 109.32 against the dollar and was last down 0.3% at 109.09. The Swiss franc was up 0.2% at 1.0983 against the euro and the Australian dollar was unchanged at 0.6847 against the dollar.