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Dollar Rises Against the Euro as Trichet Cools Markets

The dollar rose to its highest since late November against the euro as demand for the European currency fell after the European Central Bank suggested it may not raise rates again next month as some had anticipated.

The euro also dropped sharply against sterling, which rallied against several currencies after a surprise interest rate increase by the Bank of England.

The European currency hit its lowest since Nov. 22 as markets interpreted ECB President Jean Claude Trichet's remarks as offering no clear signal that rates would rise next month
and perhaps not in March.

Trichet said after the ECB left rates at 3.50% that policy remained accommodative but the bank would not use "strong vigilance" in setting monetary policy. Trichet's use of "vigilance" in his statement has frequently signaled an imminent move on rates.

Trichet "essentially downplayed the prospects of a February rate hike but," said Robert Lynch, a foreign exchange strategist for the Americas at HSBC. "Since last summer, they have been tightening every other month, and February would have been the 'on month' but it's not anymore, so that too is a notable element."

In a Reuters poll taken after the ECB meeting, the median forecast in the survey of 63 economists showed an 80% chance of a 25-basis-point rate hike in March.

Meanwhile, the dollar also rallied against the yen, reaching its highest level in over a year, above 120.00 yen and on course for its largest daily increase in a month.

Investors doubt that a rate raise next week from the Bank of Japan will boost the yen's appeal among non-Japanese investors, given that it will still be the lowest-yielding currency within the Group of Seven richest nations.

The yen has fallen against every one of its G7 peers except the Canadian dollar in the last three months, having lost 2% against the U.S. dollar and 3.6% against the euro.

"Even if the BoJ were to lift rates next week, we don't think it will be the start of 'the big unwind' in the yen carry trade," wrote UBS Securities' strategist Daniel Katzive in a note.

In the yen carry trade, investors borrow the lower-yielding Japanese currency in order to buy investments in higher-yielding currencies.

Sterling broke a 10-year high on a trade-weighted basis and rose to 18-month highs against the euro after the Bank of England surprised markets with an increase in UK rates to 5.25%.