Dollar Ends 3-Day Surge as Traders Cash In on Retail Data Rally

The dollar retreated from 1-1/2-month highs against the euro on Friday as traders sold the currency amid speculation that gains from a three-day rally were overdone.

The dollar initially rallied after the government said retail sales rose at their strongest pace since July last month, the key holiday shopping period. Still, the report also contained downward revisions for November.

"The dollar has been rallying for quite a few days, now most of the euro longs have been cleared out and the retail sales number, net of revisions, was not a big, big positive," said Richard Franulovich, senior FX strategist at Westpac Banking Corp in New York.

The euro was , having fallen to a session low of $1.2864, its weakest since Nov. 22, 2006. In the past week, the euro has shed 0.6% of its value against the dollar.

Traders said volume dwindled in the afternoon in New York as the U.S. stock and bond markets closed earlier in anticipation of a holiday on Monday.

The euro's rebound on Friday followed a sell-off on Thursday after the European Central Bank left rates unchanged at 3.5%, and signaled an increase would more likely take place in March rather than February.

The euro was down against sterling but was up from a session low of 65.96, a new 2-1/2-year low.

Sterling rose , extending the gains of the previous day when the Bank of England surprised markets by raising interest rates to 5.25%.

The dollar edged lower against the Japanese yen after touching 13-month highs on Thursday. The dollar has gained about 1% against the Japanese currency in the last week.

Most of the major U.S. fourth-quarter data has surpassed expectations and encouraged investors to roll back their forecasts for the timing of the first rate cut from the Federal Reserve.

This shift has been a major driver of dollar strength in the past few weeks. The benchmark 10-year U.S. Treasury note fell in price for the third day in a row, raising the yield to 4.78%, its highest in almost three months.

"Overall it (the data) suggested that the fourth quarter has been pretty decent, with all the numbers we've been seeing so far," said Shaun Osborne, chief currency strategist at TD Securities in Toronto.

"That should support the strong dollar trend that has emerged over the last couple of weeks," he said.

Next week kicks off with a public holiday in the United States but augurs a full U.S. economic calendar, including releases on inflation, industrial production, net capital inflows, regional business activity and consumer sentiment.

These releases could all provide some insight into how robust the U.S. economy really was in the final months of 2006 and provide the dollar with additional support.