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Monday July 3, 2006 - 11:03:45 GMT
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FOREX - Euro up on rate hike expectations, yen off high

By Natsuko Waki

LONDON, July 3 (Reuters) - The euro held near an earlier three-week high on Monday, as a stronger-than-expected euro zone manufacturing sector survey supported the view that the European Central Bank could accelerate the pace of interest rate hikes.

The yen hit a three-week high against the dollar after an upbeat reading in the Bank of Japan's quarterly tankan business sentiment poll which raised expectations for a July rate hike, but failed to sustain gains as government officials urged the BOJ to keep its zero interest rate policy.

The euro zone Purchasing Managers' Index rose to 57.7 in June, its highest in nearly six years and above a 57.4 consensus forecast, from May's 57.0. The data added weight to expectations that the ECB could signal a stepping up of its once-a-quarter pace of monetary tightening when it meets on Thursday.

"There are rising rate hike expectations from the ECB and general dollar softness in the wake of (last week's Federal Reserve) statement, so the euro is primarily gaining by default," said Adam Cole, currency strategist at Royal Bank of Canada.

"There is a renewed attack on the BOJ (by government officials) and they are talking down an interest rate hike, which is not helping the yen."

The euro had hit a three-week high of $1.2799 before trimming gains to $1.2768 by 0940 GMT.

The yen was down 0.2 percent on the day at 114.70 per dollar after hitting a three-week high of 114.11 earlier.

The euro was at 146.47 yen , within sight of last week's record high of 146.65.

Traders said potential for big moves was limited with investors unwilling to take extreme positions ahead of the U.S. Independence Day holiday on Tuesday.


The euro zone PMI survey showed manufacturing growth was boosted by domestic demand in Germany and Italy, while exports eased and inflation ticked up.

"It coincides with individual business surveys that show major euro zone countries are gaining momentum," Cole said.

Other data showed euro zone unemployment slipped to its lowest level in 4-1/2 years in May, falling to 7.9 percent from 8.0 percent in the previous month.

Some analysts now forecast a rate hike this week to 3 percent, although the consensus remains for a move in August.

"Given the hawkish comments from the ECB lately, they could maybe do a surprise rate hike or at least become even more hawkish," said Niels From, currency strategist at Dresdner Kleinwort in Frankfurt. But he added Dresdner was not expecting an ECB hike this week.

In contrast, the Fed last week toned down its rhetoric on inflation, dampening expectations for a U.S. rate hike in August and putting the dollar under pressure.


The tankan survey showed a headline diffusion index of plus 21 in the June tankan, a tad below forecasts but up from plus 20 in March and making it more likely the BOJ will raise interest rates from zero at its two-day policy meeting on July 13-14.

In a Reuters survey conducted after the release of the tankan, 32 out of 41 analysts and traders said they expected a July rate increase.

Japanese top government spokesman Shinzo Abe said the BOJ should continue its policy of zero interest rates to support the economy and said it needs to work with the government to ensure deflation is beaten.

Economics and Financial Services minister Kaoru Yosano said economic conditions were not completely set to normalise monetary policy, while Vice Finance Minister Koichi Hosokawa said he wanted the BOJ to stick to zero interest rates as Japan has not emerged from deflation.

BOJ Governor Toshihiko Fukui said he is completely open on future monetary policy.

Monday sees the U.S. Institute for Supply Management's manufacturing index for June at 1400 GMT, which is expected to edge up to 55.0 from 54.4 in May.

Reuters 2006. All Rights Reserved


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