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Friday July 14, 2006 - 09:56:55 GMT
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FOREX-Yen falls as BOJ says pace of tightening gradual

LONDON, July 14 (Reuters) - The yen hit a two-week low against the dollar and fell versus European currencies on Friday after the Bank of Japan said interest rates can be kept low for some time after lifting them from zero for the first time in six years.

BOJ Governor Toshihiko Fukui said the central bank has no intention of consecutive rate rises after it lifted benchmark overnight rates to 0.25 percent and ended an era of zero rates aimed at supporting the economy and fighting off deflation.

The BOJ also raised its official discount rate to 0.4 percent from 0.1 percent, disappointing some market players who had expected a bigger increase to 0.5 percent.

"The Lombard rate was technical but this was what the market was looking at. The BOJ also made it clear it would be slow in the pace of tightening," said Steven Saywell, currency strategist at Citigroup.

"The weakening of the yen and the reaction of the JGB market were a bit too much. I think the risk is the other way round. If growth continues to surprise on the upside the market should price in more interest rate hikes."

The dollar had risen to a two-week high of 116.16 before trimming gains to 115.73 by 0815 GMT, up 0.3 percent on the day.

The euro also rose as high as 147.19 yen , close to the record high of 147.41 set last week.

The euro was down 0.2 percent at $1.2662 , well off a one-month high of $1.2861 touched last week.

The Japanese currency was also weak on the crosses, slipping to a near eight-year low against sterling at 213.71 yen and also versus the Swiss franc at 94.30 .

Oil prices hit a record high over $78 a barrel as escalating tensions in the Middle East raised geopolitical concerns and drove investors away from risky assets like stocks.


Analysts say the yen is still not appealing from a yield point of view with interest rates in the United States and the euro zone towering much higher at 5.25 percent and 2.75 percent respectively.

Fukui said the BOJ would adjust rates gradually, slowly while checking the economy and prices. He also said the risk has faded for the economy to fall back into deflation.

December three-month euroyen futures extended gains after Fukui's comments, with investors cutting back expectations on future rate increases.

A 1.67 percent drop in the Nikkei share average <.N225> due to the record high oil price also raised doubts about future BOJ rate increases.

Markets are generally looking for the BOJ to lift rates once more this year to 0.5 percent and possibly to 0.75 percent by the end of the current business year, which ends in March.

"While it is understandable that the BOJ is cautious in ending what has effectively been a monetary policy experiment, we judge the market is underestimating the potential for interest rate increases in Japan," State Street said in a note to clients.

Japanese financial markets will be closed for a holiday on Monday.


Investors are awaiting U.S. data due later in the day to assess whether the Federal Reserve would raise interest rates again after lifting them 17 times in a row, as views are divided whether it would tighten credit again in August.

Retail sales are due at 1230 GMT and the University of Michigan's preliminary consumer sentiment report is at 1345 GMT.

The European Central Bank is also expected to raise interest rates in early August.

ECB Executive Board member Lorenzo Bini Smaghi said the level of euro zone interest rates is not hampering growth.

ECB Governing Council member Klaus Liebscher said euro zone inflation risks have risen in recent months.

© Reuters 2006. All Rights Reserved.


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