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Thursday September 7, 2006 - 00:03:33 GMT
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FOREX-Dollar up as labor cost data points to inflation risks

FOREX-Dollar up as labor cost data points to inflation risks
Wed Sep 6, 2006 5:32pm ET139

(Recasts after Beige Book survey, updates prices)

By David McMahon

NEW YORK, Sept 6 (Reuters) - The dollar rose broadly on Wednesday after data showing a jump in labor costs and solid growth in the service sector bolstered a view that the Federal Reserve may yet have to raise interest rates in coming months.

The dollar got a boost from data that showed unit labor costs in the second quarter grew 5 percent compared with the same period a year ago, the largest gain since the third quarter of 2000. For details, see [ID:nOAT000886].

Although the market sees virtually no chance the Federal Reserve will raise interest rates at its meeting this month, persistent inflation pressures could force the central bank to resume a tightening policy, drawing investors to the dollar.

"If anything it's the rise in unit labor costs that has people a bit concerned," said Michael Woolfolk, senior currency strategist at Bank of New York. "It does provide some fuel for those who feel that the Fed could be forced to raise interest rates again, perhaps early next year."

Richmond Fed President Jeffrey Lacker said in an interview with USA Today published on Wednesday that an acceleration in compensation of U.S. workers had heightened his concern on the potential for "entrenched" inflation.

Lacker was the lone dissenter in the Fed's decision to leave interest rates on hold at 5.25 percent last month, pausing after 17 straight interest rate rises.

The euro was trading down 0.1 percent at $1.2805 in late afternoon New York trade, above a session low of $1.2770 on electronic trading platform EBS.

The dollar pared much of its gains versus the euro after the Federal Reserve's Beige Book survey showed that five of the 12 Fed districts reported slowing growth, and said that a broad rise in energy costs did not appear to be boosting inflation.

Against the yen, the dollar climbed to highs of 116.90 yen before retreating to 116.65 yen, still up 0.5 percent.


Some traders noted that currencies were still trapped within relatively narrow ranges, and said that trading was mainly being driven by technical factors in a week devoid of any major U.S. economic indicators.

One of the biggest losers this week has been the pound. A mixed bag of economic data has shaken investors' conviction that the Bank of England will raise rates again in November. Expectations for higher UK rates had led speculators to raise their sterling long positions to record highs last month.

The pound was down 0.6 percent at $1.8830 , bringing its losses to the week to more than one percent.

The euro strengthened versus the Swiss franc, sterling and yen due to heightened rate hike expectations in the euro zone. European Central Bank Governing Council member Axel Weber said on Wednesday that interest rates might have to rise more than currently foreseen if upward risks to inflation come to pass.

Fellow council member Erkki Liikanen also highlighted the importance of monitoring inflation risks, adding that rates at 3 percent are still historically low in nominal and real terms.

The euro was up around 0.4 percent at 67.95 pence and up 0.40 percent at 149.35 yen . It also hit a 5-month peak against the Swiss franc around 1.5850 francs .

Elsewhere, the Canadian dollar posted strong gains across the board after the Bank of Canada left interest rates on hold, but delivered a less pessimistic view on the economy than many market players had been expecting.

The dollar was down 0.6 percent at 1.1050 Canadian dollars . (Additional reporting by Kevin Plumberg)

© Reuters 2006. All Rights Reserved.


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