(Updates prices, adds comments, changes byline)
By Kevin Plumberg
NEW YORK, Dec 14 (Reuters) - The dollar rose on Friday, posting its largest daily increase against the euro in more than three years, after strong U.S. consumer price data trimmed expectations of aggressive rate cuts from the Federal Reserve.
The dollar rallied against a group of major currencies for the third consecutive week, bolstered by a string of economic reports showing higher-than-expected growth in consumer spending and prices. The data eased some expectations that the credit crisis would drag the U.S. economy into a recession.
The Consumer Price Index for November rose at its fastest pace in more than two years, which may limit the Fed's willingness to ease rates and, in turn, preserve the return on dollar-denominated assets. For details, see [ID:nN14305067].
"More evidence of rising U.S. inflation underlines the Federal Reserve's policy bind and raises chances the central bank will stick to non-interest rate easing liquidity solutions for the struggling money market," said Ashraf Laidi, chief currency analyst at CMC Markets USA in New York.
That should "spare the U.S. currency from interest rate cuts and help it from a relative yield perspective," he added.
By mid afternoon, the euro fell 1.5 percent to $1.4412 <EUR=> against the dollar, the lowest since late October, according to Reuters data. The single currency is on track to post its largest daily fall since June 2004.
"We think this can go for another couple of cents, with the euro probably headed initially to $1.4360 or so and maybe as far as $1.40," said Marc Chandler, global head of FX strategy at Brown Brothers Harriman in New York.
"Our view is that dollar weakness has been driven by cyclical influences, not structural ones. Now that the UK and Canada are cutting rates, it looks like the dollar has bottomed against those currencies," he added.
The New York Board of Trade's dollar index, which tracks the greenback's progress against six major currencies, was up 1.2 percent at 77.467 .DXY, on pace to post its biggest daily gain since January 2006.
Against the yen, the dollar rose 1.1 percent to 113.46 <JPY=>, after rising to a five-week peak at 113.59.
FINDING SAFETY IN THE DOLLAR
Since credit markets basically froze in November, in a replay of crisis that gripped investors in August, the dollar has staged a recovery.
Hedge funds, corporate accounts and institutional investors have all shifted their bets in favor of the dollar and sold off the euro since mid November, according to client flow data from Citigroup.
However, liquidity is thin given the approaching year end, exaggerating price action and making it unclear whether the dollar can sustain a recovery into the new year, traders said.
Strategists at BNP Paribas believe U.S. investors will repatriate their profits from abroad and seek relative safety in the domestic market.
"The dollar is likely to outperform in the coming weeks," the bank said in a note. "Asset markets remain nervous with little optimism on this week's central bank action. ... Asset market volatility is dollar positive as the dollar benefits from repatriation related flows and safe haven flows."
The Australian dollar fell 1.6 percent to US$0.8620 <AUD=>, after earlier falling to around US$0.8607, the lowest since late September. Sterling dropped 1.1 percent to $2.0157 <GBP=>.
The Fed cut its benchmark federal funds rate by a quarter percentage point to 4.25 percent on Tuesday, and together with other major central banks unveiled the next day a plan to ease the global credit crunch.
Dollar, euro and sterling London interbank offered rates all fell on Friday for the second straight day following Wednesday's coordinated central bank liquidity plan.
However, the magnitude of decline was still modest, suggesting it will take time before banks become comfortable lending to each other again. (Additional reporting by Gertrude Chavez-Dreyfuss; Editing by Neil Stempleman)