Dollar skyrockets on U.K. bank woes

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NEW YORK (CNNMoney.com) -- The U.S. dollar surged against European currencies Tuesday, the same day that President Barack Obama officially took the oath of office, as the market remains focused on weakness in the global banking system.

On Monday, Britain unveiled a new bank rescue plan aimed at increasing the availability of credit and boosting bank lending. Under the plan, the British Treasury will set up an insurance program, called the Asset Protection Scheme.

The program will attempt to protect banks against further losses and guarantee bank assets backed by mortgages and other loans.

The new plan follows a $63 billion bailout of three major banks in October, coupled with an agreement to backstop bank debt.

"There's growing concern about the second round of bailouts," said Dustin Reid, senior currency strategist at RBS Global Banking & Markets. "The increasing possibility of nationalization is not being taken very well by the market."

The news of the second rescue came on the same day that Royal Bank of Scotland (RBS) announced a loss of more than £20 billion ($30 billion) in 2008, the biggest loss in British corporate history.

"Royal Bank of Scotland was pushed one step closer towards nationalization, and the government already has a 70% ownership in the bank," said Tom Benfer, vice president of foreign exchange at the Bank of Montreal. "That huge loss continues to hurt the sterling."

As a result, the British pound fell 3.4% to $1.3926 from $1.4419 on Monday, the first time the pound fell below $1.40 since July 2001.

Following the pound down was the euro, which tends to trade in line with the pound against the dollar. The euro continued Monday's trend after the European Commission said the euro-zone economy will likely shrink 1.9% this year, and Standard & Poor's downgraded Spain's AAA credit rating.

The euro fell 1.2% to $1.2909 from $1.3068, the lowest the pound has traded against the dollar since the second week of December.

The U.S. dollar also rose against the Canadian dollar after the Bank of Canada cut its interest rate by 0.5 percentage point to 1%. The central bank said its efforts to stabilize the financial markets were beginning to show signs that they are working, but "it will take some time for financial conditions to normalize."

The U.S. dollar traded up 0.97% to $1.2658 Canadian from $1.2538 Canadian on Monday.

The dollar has generally been in an upward trend against European currencies, as traders believe the economic situation in Europe will take much longer to normalize than in America. Furthermore, for many, the dollar still holds the "world's currency" title, and risk-averse traders invest in the dollar in times of trouble.

"Traders are buying the dollar in mass for safe-haven liquidity," said Reid. "People continue to look for a way to avoid risk."

But, as has been the case for several months since the dollar began its recent rise, the dollar fell against the yen. In the current trading pattern, the dollar has sunk against the yen, which traders borrow to fund investments in higher-yielding currencies. But when those currencies weaken, and investors reverse their positions, they are forced to buy back the yen, raising its value.

Accordingly, the dollar fell 0.98% against the yen to ¥89.76 from ¥90.649.

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