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Dollar Hits 20-Month Low

The euro inched up to a 20-month high against the dollar and touched its highest level ever versus the yen on Monday, boosted by expectations that the European Central Bank will boost interest rates this week.

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The dollar remained under broad selling pressure after soft U.S. factory data late last week reinforced forecasts that the Federal Reserve could cut rates next year.

The euro was well supported by prospects for a shrinking yield gap between the single currency and the dollar, with rates in the euro zone expected to rise to 3.5% at a policy
meeting on Thursday while those in the United States hold at 5.25%.

Meanwhile Japanese yields continue to be dwarfed despite a looming 25 basis point rate hike by the Bank of Japan to 0.50%.

The dollar pared losses as traders took profits on the currency's ongoing woes, but expectations for a deteriorating rate advantage will likely keep hurting the dollar, market
players said.

"On the whole, the market is being driven by people who expect more weakness in the U.S. economy," said Fumihiko Kawano, forex manager at Nomura Securities.

After rising to a 20-month high around $1.3370 in early trade, the euro pared gains to stand at $1.3325 as of 1125 am ET, down slightly on the day.

Market talk that sovereign names, probably Asian, may have sold euros above $1.3350, might have helped push the currency off its highs, said a senior trader for a major Japanese bank.

The euro inched up to a record 154.14 yen on electronic trading platform EBS, before dropping back to 154.00 yen, little changed on the day.

The dollar was up slightly at 115.55 yen but stayed in sight of a four-month low of 114.97 yen hit on EBS on Friday.

Some market participants said that media reports of an explosion on the North Korean side of the Korean Demilitarized Zone on Monday helped to prod the yen lower against major rivals.

Sterling pulled away from a 14-year high of $1.9849 hit on Friday to stand at $1.9790.

Against a basket of six major currencies, the dollar slid to its lowest level since March 2005.


ISM WEIGHS

The U.S. currency slumped on Friday after the Institute for Supply Management's survey of U.S. national manufacturing in November showed a contraction in the factory sector for the first time in three and a half years.

The ISM's key index fell to 49.5, the first time below 50 -- which indicates shrinking activity -- since April 2003. A dip below 50 has historically been a reliable predictor of Fed rate cuts, analysts say.

Besides the weak U.S. data, relatively mild reactions from European officials toward the euro's strength as well as forecasts for further credit-tightening in the euro zone augur well for the euro, said a trader for a Japanese trust bank.

"A rate rise by the European Central Bank this week is considered virtually certain, and if ECB President (Jean-Claude) Trichet says something positive afterwards about raising interest
rates next year, the euro could see further gains," the trader said.

Dealers said the dollar would likely continue to take its cues from the outlook for rate differentials.

Currently, Eurodollar futures imply that traders expect the Fed to conduct up to three quarter-point rate cuts by the end of 2007.

By comparison, the ECB is widely expected to raise rates by 25 basis points on Thursday and another 25 basis point increase is seen likely in February or March.

In addition to the ECB, the Bank of Canada, the Reserve Bank of Australia, the Reserve Bank of New Zealand and the Bank of England are all due to decide on rates this week.