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Wednesday August 2, 2006 - 23:58:21 GMT
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FOREX-Dollar rises, investors set for dovish ECB outlook

FOREX-Dollar rises, investors set for dovish ECB outlook
Wed Aug 2, 2006 7:37pm ET162

In 18th paragraph, corrects Bank of England interest rate to 4.5 percent, not 4.25 percent. (Updates prices)

By Amanda Cooper

NEW YORK, Aug 2 (Reuters) - The dollar rose against the euro on Wednesday as investors reduced their exposure to the single currency in case the European Central Bank on Thursday offers a less bullish outlook for eurozone monetary policy.

The yen staged a short-lived rally earlier after China's official news agency Xinhua quoted the Chinese central bank as saying it would pursue greater flexibility of the yuan to help cool its red-hot economy and tame inflation.

A faster appreciation of the yuan would likely put the dollar under pressure against other Asian currencies.

But with the ECB's policy meeting on Thursday, traders were wary of selling the dollar too aggressively in case the central bank proffers a more dovish outlook for the future path of interest rates, which could dent the euro.

"People are thinking that while the ECB will deliver on another 25 basis point rate hike, they are not yet willing to signal an acceleration in that rate path," said Sophia Drossos, G10 currency strategist at Morgan Stanley in New York.

"The risks to euro/dollar are to the downside if the ECB does not up the ante in terms of forward rate trajectory," Drossos said. "The euro might be vulnerable to some disappointment."

The euro was last at $1.2780, down nearly 0.4 percent on the day, having touched a session high of $1.2835 earlier. Against the yen the euro was off 0.2 percent at 146.61 yen.

Earlier in the day, the dollar slipped against the yen when official Chinese news agency Xinhua quoted officials from the People's Bank of China as saying it will increase structural adjustment, including more flexibility for the yuan to help cool its red-hot economy.

PBOC officials repeatedly have said they will allow the currency to rise gradually over time. So while these headlines did not come as a shock to the market, the yen, which often trades as a proxy for the yuan, still got a small boost.

"It doesn't specify any time period. Will it be a week from now? A month? A year?" said Ken Landon, senior currency strategist at JP Morgan in New York.

"The market's reacting to it, sure, but we need clarification. And I doubt this will be anything significantly different from what we've already heard," he said.

But by late afternoon in New York the dollar was marginally positive versus the yen at 114.63 yen, having dipped to 114.27 when wire service Market News International -- a subsidiary of Xinhua -- initially quoted the Chinese news agency's story on the PBOC.

The market largely ignored a report on private sector employment that showed a slower pace of U.S. job creation in July than forecast.

Having badly missed predicting U.S. payrolls in two of its first three months of release, the ADP National Employment Report has lost some of its ability to guide market expectations for Friday's full employment report, analysts said. For details see [ID:nNAT002165].

A Reuters poll forecasts a rise of 142,000 in the number of workers on U.S. nonfarm payrolls in July, from June's 121,000.

Fed fund futures were pricing in a 40 percent chance that the the Fed will raise rates on Aug. 8 to 5.50 percent, compared with a 35 percent chance earlier on Wednesday. Still, this shows investors are as yet undecided over the outcome of the Fed's August policy meeting.

The Bank of England also holds a policy meeting on Thursday and while it is widely expected to keep rates at 4.5 percent, the ranks of those looking for a rate rise have grown.

Sterling was roughly unchanged at $1.8761, having retreated from a session peak of $1.8795, its highest for a month. (Additional reporting by Gertrude Chavez-Dreyfuss and Jamie McGeever)

The ECB is widely expected to lift euro zone rates to 3.00 percent, the highest since November 2002. But traders will be more interested in the post-meeting statement and press conference held by central bank President Jean-Claude Trichet for an inkling of the outlook for monetary policy.


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