By Agency Reporter

Wednesday, 2 Feb 2011

LONDON: The euro rallied to its highest against the dollar in more than two months on Tuesday, boosted by signs that increasing inflation pressures will prompt a much faster rise in euro zone than in United States interest rates, Reuters reported.

Traders said the latest leg-up for the single currency during the European session was driven by demand from Middle Eastern investors, while Asian names were also seen buying back euro positions sold earlier in the day.

The dollar tumbled across the board, hitting a two and half-month trough against a currency basket as investors highlighted expectations that the Federal Reserve would lag far behind other central banks – notably the European Central Bank and the Bank of England – in raising interest rates.

“Relative rate spreads are still favouring the euro to the dollar,” a currency strategist at Danske, Mr. John Hydeskov, said.

“Pressure has intensified for the ECB to do something about inflation when it meets on Thursday. The ECB has hiked rates when inflation was previously at this level, so it’s possible they could do it again,” he said.

Data on Monday showed a higher than expected 2.4 per cent year-on-year rise in euro zone inflation.

With inflation hovering above the central bank’s target of just below two per cent for the second month, investors expect ECB President, Mr. Jean-Claude Trichet to keep his hawkish tone on Thursday.

Implied interest rate futures suggest nearly an 80 per cent possibility that the ECB will raise rates by 25 basis points in August from the current record low of one per cent.

Speculation that rates will rise has kept the two-year yield spread between German and US government bonds at around 80 basis points, its widest in two years.

The euro rose as high as $1.3776, its strongest since late November. The single currency was well supported as market concern over political unrest in Egypt abated somewhat.

Also helping to boost the euro were a fall in the German jobless rate to 7.4 per cent last month from 7.5 in December, and strong final readings of purchasing managers’ indices in Germany and the wider euro zone, which supported the view the overall euro zone recovery is progressing.

Tighter yield spreads between bonds of weaker periphery euro zone countries against safe-haven German debt also supported the euro as they eased concerns about the region’s debt problems for now.

The euro broke above $1.3740, around the 61.8 per cent retracement of its November-January fall, which technical analysts said provided support and may open the way to $1.40.

The US currency slipped to a four-week low around 81.54 yen, helping to push the dollar index, which tracks the US currency’s value against a basket of other currencies, as low as 77.294, its weakest since early November.

Source: Punch