Dollar falls almost 2 cents as markets sell off

The Canadian dollar closed almost two cents lower, and the major stock markets dropped Tuesday amid a stronger greenback and falling commodity prices.

Meanwhile, China's decision to increase its interest rates to cool inflation raised concerns over slower growth in a key market for Canadian resources.

The Bank of Canada later added to the gloom by warning that the Canadian economy will take longer to recover than anticipated.

And investors worried about earnings in the U.S. banking sector as Bloomberg reported that bond traders Pacific Investment Management and BlackRock Inc., as well as the Federal Reserve Bank of New York, were seeking to force Bank of America to repurchase $47 billion US in mortgage-based bonds held by its Countrywide Financial Corp. unit.

The Canadian dollar fell to its lowest level in nearly a month, at one point losing more than two cents from Monday's close.

The loonie closed down 1.7 cents to 96.91 cents US after falling as low as 96.4 cents earlier in the session.

In Toronto, the S&P/TSX composite index ended trading down 97.5 points, or 0.8 per cent, to 12,570.5.

In New York, the Dow Jones industrial average fell 165.07 points, or 1.5 per cent, to 10,978.62.

The Nasdaq composite index lost 43.71 points, or 1.8 per cent, to 2,436.95, while the S&P 500 index declined 18.81 points, or 1.6 per cent, to 1,165.90.

Oil down

The November crude contract on the New York Mercantile Exchange closed down $3.59, to $79.49 US a barrel.

The November bullion contract on the Nymex  ended down $36.10, to $1,335.10 US an ounce.

The People's Bank of China announced Tuesday it was raising its one-year lending rate 0.25 per cent to 5.56 per cent, and its one-year deposit rate by 0.25 per cent to 2.5 per cent.

And the U.S. dollar regained some ground after U.S. Treasury Secretary Timothy Geithner sought to downplay fears that China and the U.S. are heading toward a currency war, saying that no country "can devalue its way to prosperity."

"Geithner's promise not to pursue dollar devaluation provided quite pronounced relief for the currency," said Daragh Maher, deputy head of global foreign exchange strategy at Credit Agricole.

The dollar had weakened considerably in recent weeks as speculation grew the U.S. Federal Reserve will embark on a quantitative easing, designed to increase liquidity. The move would involve the central bank in buying government bonds, which increases the supply of dollars and weakens the currency.

"Attempts to slow growth in China has a direct impact on commodities as any type of slowing in growth expectations from here for China would require less commodities being bought and therefore there is some downward pressure on those commodities as well as the Canadian dollar," said Camilla Sutton, chief currency strategist at Scotia Capital.