Dollar falls, currencies volatile on trade war escalation

• Dollar hits 3-month low, euro rises to highest since November 13
• Risk appetite fragile as investors assess trade war impact
• China keeps 2025 economic growth target unchanged at roughly 5%

SINGAPORE, March 5 (Reuters) - The dollar dropped to a three-month low on Wednesday as markets reeled from a trade war triggered by U.S. President Donald Trump, who again vowed reciprocal tariffs in his first speech to Congress since taking office.

Moves in currencies were volatile as investors fretted about the impact of escalating global trade tensions on the world economy.

In an address to Congress, Trump said further tariffs would follow on April 2, including "reciprocal tariffs" and non-tariff actions aimed at balancing out years of trade imbalances.

The dollar initially ticked higher as Trump was speaking, though later erased those gains to hit a low of 105.46 against a basket of currencies =USD, its weakest since December 6.

Sterling GBP=D3 rode on the weaker dollar to notch a three-month high of $1.28025.

Investors have sold the dollar in a reversal of the so-called "Trump trades" which first gathered steam late last year, as they become increasingly concerned with the growth outlook for the world's largest economy, which is already showing signs of a slowdown.

"Rising inflation expectations and tariff angst are threatening the path of the U.S. economy towards a soft landing," said Boris Kovacevic, global macro strategist at Convera.

"This 'macro over tariffs' narrative underscores the transition from U.S. exceptionalism to rising stagflation risks. Sure, tariff hikes are theoretically positive for the dollar. However, investors are looking beyond the short-term safe haven flows and are worried about a prolonged growth slowdown."

The U.S. President's remarks to Congress comes just after he followed through on new 25% tariffs on imports from Mexico and Canada that took effect on Tuesday, along with a doubling of duties on Chinese goods to 20%.

Canada and China quickly acted in kind, while Mexican President Claudia Sheinbaum vowed retaliation but without details, saying she would announce Mexico's response on Sunday.

The Canadian dollar CAD= lost 0.23% to stand at C$1.4425, while Mexico's peso MXN= recovered some of its losses and last stood at 20.6141 per dollar.

Sowing further confusion, Commerce Secretary Howard Lutnick told reporters that U.S. officials had spoken with Mexico and Canada "all day" and might still work out a partial resolution with the two neighbours, adding that they needed to do more on the fentanyl front.

Elsewhere, the Japanese yen JPY=EBS gained 0.15% to 149.58 per dollar.

Bank of Japan Deputy Governor Shinichi Uchida said on Wednesday the central bank can proceed with interest rate hikes at a pace in line with market expectations.

The euro EUR=EBS similarly rose to a three-month top of $1.0639, drawing support from news that the parties hoping to form Germany's next government agreed to create a 500 billion euro ($530.95 billion) infrastructure fund and to overhaul borrowing rules in a tectonic spending shift to revamp the military and revive growth.

"If we get an unexpectedly large lift in the debt brake, I think it can probably push the euro up further, and of course, any further announcements on increased defence spending will also bolster expectations for European growth and therefore support the euro," said Carol Kong, a currency strategist at Commonwealth Bank of Australia.

BEIJING'S SUPPORT

In Asia, China unlocked more fiscal stimulus on Wednesday, signalling greater efforts to boost consumption to protect economic growth amid heightened trade tensions with the United States. Policymakers as expected set this year's GDP goal at roughly 5%.

That kept the yuan steady against the greenback, with the onshore unit CNY=CFXS rising 0.08% to 7.2615 per dollar.

The offshore yuan CNH=D3 eased 0.1% to 7.2624 per dollar.

"Premier Li's pledge at the opening of the NPC, to provide additional stimulus to catalyse domestic consumption, should be well received by markets," said Brian Arcese, a portfolio manager at Foord Asset Management.

"We, however, must await additional detail on what exactly these consumer stimulative measures include to more fully understand their potential impact."

Traders and analysts said the growth target against a backdrop of Sino-U.S. tensions and weak sentiment meant monetary settings, particularly banks' reserve ratio requirements (RRR), will be reduced. That could pressure the yuan further, given its relatively low yields.

The Aussie AUD=D3, meanwhile, traded 0.3% lower at $0.6254, as risk aversion in markets overshadowed upbeat domestic data that showed Australia's economy expanded at the fastest pace in two years in the December quarter.

The New Zealand dollar NZD=D3 similarly fell 0.21% to $0.5654, further pressured by news of Adrian Orr's sudden resignation as head of the Reserve Bank of New Zealand, three years before his current term ends. His role will finish on March 31.

($1 = 0.9417 euros)