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Dollar Sinks on Speculation of Euro Zone Rate Hike

The dollar touched a two-year low against the euro on Thursday and fell against most other major currencies amid speculation euro zone rates will rise further and as investors avoided long positions ahead of a G7 meeting of finance ministers.

The dollar's slump started earlier in the session after the European Central Bank kept interest rates on hold at 3.75% as expected. But ECB chief Jean-Claude Trichet signaled the central bank was likely to raise rates in June or beyond to prevent an acceleration on inflation.

Traders and investors also avoided betting on the greenback ahead of Friday's start of a meeting with finance ministers and central bankers from the Group of Seven wealthiest nations.

Global economic imbalances and currencies will be among the topics of discussion.

"The combination of (Jean-Claude) Trichet's comments and the start of the G7 meeting was more than enough to fuel selling of the dollar," said Samarjit Shankar, a global foreign exchange strategist at Mellon Financial Corp. in Boston. "The bottom line is that the ECB has room to raise rates, while the Fed in contrast may start easing."

One year ago, the dollar tumbled some 7% against the Japanese yen in a month after the G7 appeared to support a weaker dollar.

"People are just saying going into G7 they don't want to be long dollar/yen ... they are trying to balance their portfolios ahead of the weekend and G7 is on their minds," said Matthew Kassel, director of foreign exchange with ING Capital in New York.

Shankar added he expects European officials to address the dollar's slump during the G7 meeting and in particular mention the strength in the euro against the Japanese yen.

The ECB's task has been complicated by the euro's surge to record highs against the Japanese currency, which euro zone politicians argue gives Japanese exporters an advantage in global markets.

Earlier in the session the euro pared some of its gains versus the yen after Trichet said that a recovery in Japan's economy should be reflected in currency rates.

"With the euro at 160 or higher against the yen and the BOJ having no intention of raising rates, the only way the Europeans can get euro-yen to come down is by delaying their own rate hikes," said Boris Schlossberg, currency strategist at DailyFX.com.