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Dollar Gains As U.S. Rate Cut Outlook Dims

The dollar firmed as U.S. data strengthened the case against the Federal Reserve cutting interest rates early next year to prop up the economy.

In the latest data to show resilience in the economy, the U.S. government said the number of people filing initial unemployment claims last week fell more sharply than economists had expected. That underpinned the dollar and supported views of a robust labor market.

"Obviously, the data that we've seen so far this week ... is actually doing a fairly good job of supporting the fact that the U.S. economy is not on the cusp of implosion like some in the bond market might think," said Lara Rhame, senior currency strategist at Credit Suisse in New York, "This is an environment where the market remains very thirsty for any kind of yield," she added.

Remarks by European Central Bank Governing Council Member Vitor Constancio saying euro zone inflation "is under control," fueled some modest selling of the euro against the dollar earlier, traders said, as that undermined prospects of further rate hikes in the region.

Against the Swiss franc, the dollar hit three-week highs while the euro rose to four-week peaks after the Swiss National Bank raised rates but halved its 2007 inflation outlook.

The dollar had come under almost unabated pressure over the last month as investors bought into the notion that the U.S. economy was slowing enough to warrant a cut in official interest rates by the Fed in early 2007.

However, while housing and manufacturing data have been weak, reports on employment, service sector activity and consumer spending painted a healthier picture of the U.S. economy and financial futures traders have priced in almost no chance of a rate cut in the first quarter.

Also benchmark U.S. Treasury prices fell, sending yields to three-week highs around 4.59% on the 10-year note, which offered further support to the dollar, particularly ahead of
Friday's reading on consumer inflation.

"I think that along with Treasury yields pushing higher, we are seeing a good dollar push," said one trader with a U.S. asset management firm.

"Tomorrow after CPI we could see more dollar buying if it is a good number. This will push yields even higher," he said.

Wall Street economists are looking for the government's consumer price index to reflect that prices outside the food and energy sectors rose at a 0.2% pace in November, versus October's 0.1% rise.

"As long as EUR/USD remains below $1.3190 in Friday European and Asian trade, it will be expected to drop to the $1.3140 support in the event of a 0.2% (rise) in core CPI," said Ashraf Laidi, chief FX analyst at CMC Markets US in New York.

Meanwhile, prospects for a rate hike in Japan seemed to be fading after a newspaper report suggested that the Bank of Japan will stand pat at its meeting on Dec. 19.