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Tuesday June 10, 2008 - 22:29:03 GMT
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FOREX NEWS-Dollar rallies as Bernanke focuses on inflation

Tue Jun 10, 2008 4:12pm EDT

(Updates prices; adds comments, byline)

* Dollar jumps broadly, touches 3-1/2-month high vs yen

* Bernanke's inflation remarks spark rate rise talk

* Bank of Canada keeps benchmark interest rate steady

By Steven C. Johnson

NEW YORK, June 10 (Reuters) - The dollar soared against the euro on Tuesday and hit a 3-1/2-month peak versus the yen after Federal Reserve Chairman Ben Bernanke continued his tough talk on inflation, boosting expectations of higher interest rates.

Speaking late on Monday, Bernanke said the U.S. central bank would resist rising inflation expectations and added that the latest surge in energy costs was stoking price pressures.

He also said the risk of a sharp downturn in the U.S. economy had receded, sending U.S. bond yields soaring and putting the euro on track for its biggest two-day decline against the dollar in three years.

Bernanke's comments "support the notion that the Fed is taking the fight against inflation very seriously and might even consider interest rate hikes before year-end," said Matthew Strauss, currency strategist at RBC Capital Markets in Toronto.

Last week, Bernanke shocked markets by saying a weaker dollar was adding to inflation risks -- a rare departure from usual Fed policy of not commenting on the dollar.

U.S. Treasury Secretary Henry Paulson on Monday declined to rule out market intervention to stabilize the dollar, comments he let stand in a television interview on Tuesday.

The euro has lost a touch more than 2 percent against the dollar over the last two sessions, leaving it en route to its worst two-day performance since June 2005. It last traded at $1.5450 <EUR=>, down 1.2 percent from late Monday in New York.

"There's been a definite change in tone," said Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Connecticut.

"We've moved from a kind of 'benign neglect' (on the dollar) to what is, to my mind, verbal intervention," he said, adding that with oil prices surging to record highs, "there's nothing much to be gained by weakening the dollar further."

The dollar also rose 1 percent to 107.44 yen <JPY=>, a 3-1/2-month high, and strengthened by 1.5 percent to 1.0427 Swiss francs <CHF=>.

The dollar also gained 1.2 percent against a basket of currencies to 73.696 .DXY. It was the biggest one-day jump in the dollar index since January 2006 at current prices.

Federal funds futures FFF9 suggested that traders are fully pricing in the prospects of the Fed lifting its fed funds target interest rate by half a percentage point by October and by a total of three quarters of a point by year-end.

INFLATION BUSTERS

Though Bernanke was eclipsed last week by European Central Bank President Jean-Claude Trichet, who signaled a near-term ECB rate hike to combat soaring euro zone inflation, Bernanke's comments this week put the spotlight back on the Fed.

Bernanke's most recent comments indicated that top policy-makers are trying to limit the inflationary impact from oil CLc1 rising to nearly $140 a barrel ahead of this weekend's G7 meeting in Japan.

Scotia Capital strategist Steve Malyon called them "a notable sharpening of the inflation rhetoric compared with his remarks last week."

Dallas Fed President Richard Fisher also said the Fed will not allow inflation to get out of control and is aware that a weaker dollar could feed into higher prices.

Meanwhile, the Bank of Canada surprised markets by holding interest rates steady at 3 percent on Tuesday, signaling an end to its rate-cutting cycle because of strong price pressures.

The U.S. dollar last traded at C$1.0227 <CAD=>, little changed from late on Monday. (Additional reporting by Nick Olivari; Editing by James Dalgleish)

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