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Tuesday April 4, 2006 - 10:40:43 GMT
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FOREX-Euro firms as ECB May rate hike expectations grow

FOREX-Euro firms as ECB May rate hike expectations grow
Tue Apr 4, 2006 6:34 AM ET8

By Ana Nicolaci da Costa

LONDON, April 4 (Reuters) - The euro hit a two-week high versus the dollar and a two-month peak against the yen on Tuesday as expectations grew the European Central Bank would raise interest rates in May, raising yield appeal for the single currency.

News agency Market News quoted a Eurosystem official as saying a majority of the ECB Council wants a rate rise in May, and quoted central bank sources saying a majority of the Council was now convinced the economy could withstand rate rises.

Just days ahead of the ECB's monetary policy meeting, the report reinforced an already widely held market view that rates would rise to 2.75 percent in May. But the bank is expected to keep interest rates on hold when it meets this Thursday.

"The rate story and relative yields still continue to be the major driver of FX market sentiment so the ECB council members are basically justifying what's priced in to the euribor interest rate futures curve -- that is a May rate hike," said Kamal Sharma, currency strategist at Bank of America.

The euro hit a two-week high at $1.2184 immediately after the MNSI report, before trimming gains to $1.2157 by 1015 GMT, up 0.3 percent on the day. It also hit a two-year high of 1.5857 Swiss francs earlier in the day.

The single currency hit a two-month high against the yen at 143.25 and was last up 0.3 on the day.

The yen has been under pressure on expectations that Japanese investors, frustrated by near-zero interest rates at home, would buy higher-yielding assets abroad at the start of the new fiscal year.

The dollar was steady vesus the yen at 117.65 .


Investors will pay close attention to ECB President Jean-Claude Trichet later this session when he speaks at a conference in Frankfurt, but analysts said he was unlikely to change his hawkish rhetoric.

"The market is already looking to the ECB meeting (on Thursday) and expects the ECB to keep a hawkish stance, which constitutes an upward risk for the euro/dollar," said Johan Javeus, currency strategist at SEB in Stockholm.

Also on the calendar, Chicago Fed President Michael Moskow speaks in Frankfurt and Dallas Fed's Richard Fisher and Richmond Fed's Jeffrey Lacker are also scheduled to speak.

Euro zone producer prices rose in line with expectations in February, by 0.5 percent month-on-month.

Data on Monday showed that euro zone manufacturing grew at its fastest pace in more than five years in March, contrasting sharply with a surprising fall in the Institute for Supply Management's U.S. manufacturing activity index for the same month.

Investors expect the Fed to raise interest rates from the current 4.75 percent in the coming months but they are keen to know when the central bank would pause its tightening campaign that began in June 2004.


The dollar earlier fell to the day's lows against the yen after a Hong Kong newspaper quoted a vice chief of China's parliament as saying Beijing can stop buying dollar-denominated bonds and reduce its holdings of U.S. debt.

But the U.S currency quickly recovered after a spokesman from China's central bank said that the comments reflected the parliamentarian's own view.

Speculation of reserves diversification in China has pressured the dollar in the past as the country now holds the world's largest reserves, surpassing Japan in recent months.

The United Arab Emirates central bank said on Tuesday it has postponed until next month a decision on whether to convert 10 percent of its reserves from dollars to euros.

Qatari central bank governor said the central bank could hold up to 40 percent of its reserves in euros but could not say what proportion of the bank's reserves were now in euros.

Kuwait's central bank said euros account for a substantial part of the bank's reserves.

"The story of central banks shifting out of dollars has been a problem for the dollar. But the Fed has been aggressive and U.S. interest rates are rapidly going up. So the cost is getting high to shift out of dollars," Javeus said.

"The Fed action has served as a counterweight to the diversification story."

© Reuters 2006. All Rights Reserved.


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