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Tuesday June 6, 2006 - 11:16:11 GMT
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FOREX-Dollar holds firm after Fed chief warns on inflation

FOREX-Dollar holds firm after Fed chief warns on inflation
Tue Jun 6, 2006 6:51am "
(Updates prices, adds comments, changes byline)

LONDON, June 6 (Reuters) - The dollar held firm against the euro and the yen on Tuesday after comments from Federal Reserve Chairman Ben Bernanke left the door open for another U.S. interest rate rise later in June.

Speaking at an international monetary conference in Washington on Monday, Bernanke suggested the Fed needed to be vigilant to make sure inflation stays under control, even as the U.S. economy starts to shift to a slower pace of growth.

"Bernanke's comments are offering some lingering support for the dollar although we haven't seen a spectacular move higher," said Steven Pearson, chief currency strategist at HBOS.

The possibility the Fed will raise rates for the 17th successive time to 5.25 percent sparked a round of dollar short-covering, helping the U.S. currency recover from a sell-off after data last Friday showed U.S. employment growth last month was slower than expected.

But the dollar's recovery was limited as some investors worried about the state of the U.S. economy.

"Higher rates are a supportive factor for the dollar but if the U.S. is raising rates due to inflation pressures, not growth, the impact on the dollar will be limited," said Tony Norfield, head of FX research at ABN AMRO.

The euro was down almost a third of a percent at $1.2870 by 1015 GMT after hitting one-year highs just short of $1.2980 on Monday before Bernanke spoke.

The dollar traded flat at 112.31 yen .

The euro found some support from euro zone rate expectations, breaking through 145 yen to a six-week high of 145.10 yen .

Most analysts expect the European Central Bank to lift rates by 25 basis points to 2.75 percent at its policy meeting on Thursday and to signal more credit tightening is likely in store.

Speculation is still simmering about a potential half-percentage point increase, a view that was underscored after data on Tuesday showed the euro zone's service sector grew at its strongest pace in nearly six years in May.

Euro zone officials so far appear unfazed by the euro's rise to one-year highs against the dollar, although French Treasury Director Xavier Musca said on Tuesday officials are watching developments closely.

EU Monetary Affairs Commissioner Joaquin Almunia and Eurogroup chairman Jean-Claude Juncker have asked for more regular dialogue with ECB President Jean-Claude Trichet, a European Commission spokeswoman said on Tuesday.

The euro group of euro zone finance ministers meets in Brussels later on Tuesday.

So far this year the dollar has tumbled 8 percent against the euro and 5 percent versus the yen, with the slide accelerating after the Group of Seven industrial powers called in April for China and other trade surplus countries to allow their currencies to strengthen.

Fed funds futures indicate a more than 70 percent chance of rate hike at the Fed's two-day policy meeting that starts on June 28, up from less than 50 percent on Friday.

Even if the Fed raises rates later this month it would likely be the last before the central bank takes a break from the two-year run of credit tightening, just as other major central banks look set to bump up rates.

Traders said any recovery was likely limited, with the renewed focus on a weaker dollar helping rein in the massive U.S. trade deficit and playing a role in correcting global imbalances.

Global imbalances are also expected to be a focus later in the week with the release of U.S. trade figures on Friday, just as the Group of Eight finance ministers meet in St. Petersburg.

Japanese Finance Minister Sadakazu Tanigaki said the impact of high energy prices on the global economy would be a topic at the G8 meeting.

© Reuters 2006. All Rights Reserved.


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