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Wednesday May 7, 2008 - 20:24:08 GMT
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FOREX NEWS-Dollar up on strong data, Fed inflation talk

Wed May 7, 2008 4:18pm EDT

(Recasts, updates prices, adds comment, byline)

By Steven C. Johnson

NEW YORK, May 7 (Reuters) - The dollar rose on Wednesday as a surprise advance in U.S. productivity added to gains booked after a Federal Reserve official said the central bank must stand ready to raise interest rates to combat inflation.

A sharp decline in euro zone retail sales also weighed on the euro and suggested that the European Central Bank may have to cut its own benchmark interest rate before the year is out.

Speaking in Denver late on Tuesday, Kansas City Fed President Thomas Hoenig said the Fed has to be ready to hike rates in a timely manner to fend off "troublesome" inflation and hinted he would not support more interest rate cuts. For details, see [ID:nN06528406].

Though Hoenig is not a voting member on the U.S. central bank's rate-setting committee, analysts said his position appears to be gaining ground at the bank as rising oil and food prices threaten to entrench higher inflation.

"We have moved into a phase where there's a sense, even among (voting Fed officials), that further rate cuts may do little good and some inflation harm," said Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Connecticut.

The Fed cut its benchmark rate to 2 percent last week but hinted it was ready to pause an easing campaign that began in September, when rates stood at 5.25 percent.

The euro tumbled to a session low of $1.5367 before easing to $1.5404, still down 0.8 percent on the day. Against a basket of six major currencies, the dollar was up 0.7 percent at 73.485 .DXY.

Against the yen, the greenback was little changed at 104.75 <JPY=> after earlier climbing as high as 105.58.

The dollar also got a boost from data showing higher-than-expected productivity gains in the first quarter and a lower-than-expected rise in unit labor costs, which reassured investors that inflation, while rising, is not yet spiraling out of control.


Inflation has been a top concern in the 15-country euro zone, and markets widely expect the ECB to keep rates at 4 percent when it meets on Thursday.

But analysts say the euro could falter if ECB President Jean-Claude Trichet acknowledges increased downside risks to growth in the post-meeting news conference.

A run of poor economic data has pressured the euro in recent weeks after it hit a record high above $1.60, peeling away perceptions that the euro zone was insulated from a U.S. downturn.

"All the data suggest is that the outlook is deteriorating for Europe, and that's consistent with downward pressure on the euro," said Teis Knuthsen, currency strategist at Danske Markets in Copenhagen.

At the same time, increased optimism about the U.S. outlook was seen boosting the dollar. "There is a sense that finally time is on the dollar's side," Ruskin said.

The dollar also rose sharply against sterling, which hit an 11-week low at $1.9504 <GBP=> after weak consumer sentiment and employment data kept investors focused on slower UK growth.

Economists expect the Bank of England to hold interest rates steady at 5 percent when it meets on Thursday.

Some analysts, however, said that investors may be getting too optimistic about the dollar's outlook, adding that the still-struggling U.S. economy will keep the Fed from raisig rates this year.

"The Fed probably cannot hike rates until the housing market has stabilized, and that's some time away," said Bertrand Delgado-Calderon, currency analyst at IDEAglobal in New York. (Additional reporting by Nick Olivari; Editing by Jonathan Oatis)

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