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Tuesday May 20, 2008 - 11:08:06 GMT
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FOREX NEWS-Euro hits 3-week high on ECB rate speculation

Tue May 20, 2008 6:57am EDT

(Changes byline, recasts, adds quotes, updates prices)

By Naomi Tajitsu

LONDON, May 20 (Reuters) - The euro hit a three-week high against the dollar on Tuesday, boosted by comments from a German think-tank that euro zone interest rates would soon rise.

That helped drag the U.S. unit down to a one-month low against a basket of six major currencies.

Wolfgang Franz, the president of the ZEW economic research institute, said that he thought the European Central Bank will raise rates soon, even as a survey on investors' morale by the institution unexpectedly worsened for the second straight month.

The ZEW's gauge of expectations for Germany fell to -41.4 in May from -40.7 in April. Click on [ID:nBAE001218]. Despite his remarks about an ECB rate rise, Franz said that stellar German economic growth seen in the first quarter would not continue.

The euro was initially pressured by the weak ZEW reading, but then shot up on Franz's rate comment. Analysts said the move reflected market uncertainty about the ECB's rate outlook, given that the economy is slowing amid persisting inflation risks.

"Even though the number wasn't fantastic, the ZEW president is saying that the ECB is going to raise rates in the near future," said Paul Mackel, director of currency strategy at HSBC Markets.

"The fact that the euro has responded to contrasting signs highlights the current sentiment."

The euro was also supported by a rise in German producer price inflation to a 20-month high, which added to the argument that the ECB may hike rates from the current 4 percent later in the year [ID:nL20351479]

The euro climbed a full percent to $1.5674 <EUR=>, clocking its highest level since late April.

The dollar weakened across the board, falling against a basket of currencies as euro gains added to downward pressure in the currency due to persistent jitters about the U.S. economic outlook and as oil prices hovered near record highs.

The dollar index, which tracks the currency's performance against units of its six major trading partners, fell more than 0.8 percent to 72.397 .DXY, its lowest since April 24.

The U.S. currency fell 0.4 percent to 103.95 yen <JPY=>.

There was little reaction in currency markets to the Bank of Japan keeping its borrowing costs on hold at 0.50 percent as expected on Tuesday. [ID:nT37919]

INFLATION CONCERNS

The U.S. currency had been boosted on Monday after the private Conference Board's leading indicator index showed a rise of 0.1 percent in April to match the increase in March, which followed five straight months of declines.

But while that data backed those arguing the U.S. slowdown may be bottoming out, others said that further fallout from the global credit crunch would leave the economy entangled in a scenario of slowing growth versus higher inflation.

Continuing concerns about the inflationary impact of surging oil prices has also raised nervousness ahead of U.S. producer price data due later in the day.

"Since last summer, higher energy prices have pushed PPI up strongly, and whilst CPI has increased as well, the gap between PPI and CPI has widened, suggesting that with consumer confidence so weak, firms have not been able to pass on the full impact of higher producer prices to the consumer," Calyon said in a note clients.

Analysts said they were also awaiting a reading of German business sentiment due on Wednesday to glean a better picture of whether Germans expect their country's surprisingly strong economic expansion to continue.

Forecasts are for the Ifo May business climate index to dip to 102.0 from 102.4 in April ECONDE, and analysts said that a disappointing reading may sting the euro.

"The market is very sensitive to any signs of deteriorating sentiment in the euro zone and any risk that the euro zone is playing catch-up with softness we've seen in the U.S," said Adam Cole, global head of currency strategy at RBC Capital Markets.

(Additional reporting by Veronica Brown)

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