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* Dollar falls on fears of a less hawkish Fed, write-downs
* Dollar index set for largest weekly loss since March 30
* ECB official says rates must rise
By Vivianne Rodrigues
NEW YORK, June 20 (Reuters) - The dollar fell broadly on Friday as fears of further write-downs in the U.S. financial sector raised speculation the Federal Reserve would not signal a shift toward tighter monetary policy when it meets next week.
Rising oil prices, more inflation-busting talk from a European Central Bank official and an unexpected surge in German producer prices in May to a near two-year high added to selling pressures on the greenback.
These developments were seen as confirmation that the European Central Bank would deliver an interest rate hike next month, flagged at the bank's last policy meeting. A hike would further enhance the euro's yield appeal against the dollar.
"The dollar is ending the week on a negative tone," said Matthew Strauss, a currency strategist at RBC Capital Markets in Toronto. "Write-downs on Wall Street may not be over and the U.S. economy is not strong enough to support a series of rate hikes despite the Fed's hawkishness."
Fed Chairman Ben Bernanke's tough inflation talk boosted the dollar in recent weeks, but analysts reckon that signs of more turmoil on the U.S. financial sector could prevent the central bank from following the hawkish words with action.
The Fed meets on June 24-25 and is widely expected to leave the fed funds rate target at 2 percent after slashing it by 3.25 percentage points since September. The statement accompanying the decisions will be closely watched for clues on the future course of monetary policy.
"Expectations are growing on the street that Bernanke is going to step away from the overtly hawkish tone that he put out to the market two weeks ago," said Greg Salvaggio, vice president of trading at Tempus Consulting in Washington. "Speculation is he is going to signal that rate hikes will not be forthcoming in as quick a manner as people want to believe they will."
U.S. interest rate futures have reduced the chances of a 25 basis points rate increase in August to about 40 percent from 48 percent. Expectations of a year-end rate hike have also been trimmed.
Late on Thursday, Moody's Investor Service downgraded the insurance arms of Ambac Financial Group (ABK.N: Quote, Profile, Research, Stock Buzz) and MBIA Inc (MBI.N: Quote, Profile, Research, Stock Buzz). On Friday, Merrill Lynch cut the 2008 earnings estimates of U.S. large-cap regional banks, citing higher loan losses and reserve building.
The New York Board of Trade's dollar index, which tracks the dollar's performance against a basket of six currencies, dropped to a session trough at 72.932 .DXY, the lowest level since June 10, according to Reuters data.
It was poised for its largest weekly loss since March 30. The euro jumped to an intraday peak of $1.5651 <EUR=>. It was last up 0.7 percent at $1.5616.
ECB Executive Board member Lorenzo Bini Smaghi, writing in a column for the Financial Times published on Friday, said the central bank will have to raise interest rates unless the euro zone services sector improves productivity to counter higher commodity prices.
At the same time, German producer price inflation rose at a faster-than-expected pace in May to its highest level since July 2006, fanned by surging energy costs.
"That's pushing the euro up. With the ECB forever concerned about inflation and the inflation data out of Europe coming in stronger than expectations, that's going to keep the focus on rate hike expectations in the euro zone," said Ron Simpson, director of FX research at Action Economics in Tampa, Florida.
Oil prices CLc1 earlier topped $136 a barrel, rebounding from Thursday's sharp sell-off after China's move to raise fuel prices. Analysts said the thinking in the market was that China's fuel price increase may actually boost demand.
The dollar has tended to fall when oil prices surge due to speculation that oil-producing countries may use the increased dollar-denominated windfall from crude exports to buy euros and other currencies to diversify their portfolios.
Worries about the health of the U.S. financial sector knocked stocks and sent the dollar tumbling against the Japanese yen. The dollar fell as low as 107.14 yen <JPY=>. It was last down 0.8 percent at 107.17 yen. (Additional reporting by Lucia Mutikani; editing by Gary Crosse)