The dollar climbed to a three-week high against the euro as reports that US retail sales rose in April and consumer confidence improved in May boosted optimism the economy will avoid falling into recession.
Triggering the US currency's gains earlier on Friday, figures showed accelerating inflation in the euro zone, which may prevent the European Central Bank from cutting interest rates again, as it did yesterday, to boost growth. Separately, a German report showed retail sales fell in March.
"The dollar has got room to rally" against the euro given the contrast in reports from the US and the euro region, said Lara Rhame, a foreign exchange economist at Brown Brothers Harriman & Co.
The US currency rose toUS$0. 8754 per euro, from US$0.8814 late yesterday in New York. It reached its high for the day after a University of Michigan preliminary index of consumer sentiment for May unexpectedly rose. The dollar reached as strong as US$0.8741 per euro, its highest since US$0.8699 on April 18.
Signs of reviving US growth also caused investors to scale back expectations the Federal Reserve will cut interest rates further, past a reduction of as much as a half-point forecast when policy-makers meet next week. A half-point cut would drop the Fed's benchmark rate to 4 percent.
Robert Blake, senior economist at Royal Bank of Scotland Financial Markets, said investors may have to factor in the potential for inflation to become a concern in coming months.
Accelerating prices could be a gloomy prospect for the dollar, by causing US debt prices to tumble and scaring away foreign investors, he said.
"Inflation is never good for a currency," said Blake.
Investors may have to start thinking about the possibility the Fed will need to start raising rates again to tame inflation, he said.
On the week, the dollar rose 1.8 percent against the euro, its biggest gain in eight weeks, and strengthened 0.9 percent versus the yen.
The April 18 high of about 87 cents was also the dollar's strongest level so far this year, and is likely the next target for traders trying to push the currency higher, analysts said.
Helping spur dollar gains, US retail sales rose 0.8 percent last month, compared with forecasts for a 0.1 percent gain. In contrast, sales in Germany fell 1.9 percent in March from the prior month. Expectations had been for a 0.5 percent increase.
The euro has shed about 1 cent since the ECB surprised investors yesterday by lowering rates a quarter point to 4.5 percent, after weeks of statements from officials suggesting inflation was too high to consider a cut.
While some investors said the move to drop rates was in the right direction given signs of slowing growth, they took issue with the way the bank communicated its intentions.
"The [currency] market is effectively punishing the ECB" for the bank's lack of transparency and its inconsistent message, said Daniel Scherman, who helps manage US$24 billion of bonds at MFS Investment Management in Boston. "It's difficult for me to imagine the ECB in the near-term redeeming any modicum of credibility." Concern about the euro and the cost of hedging against potential euro declines are making MFS reluctant to shift funds out of Treasuries and into European bonds, he said.
Today's reports are helping the dollar and hurting the euro as they are influencing how international money managers hedge their holdings, said David Johnson, head of institutional and hedge fund currency sales at HSBC Bank USA.
US fund managers who had been holding European stocks or bonds without a currency hedge might now sell euros to protect against further declines in the 12-nation currency, said Johnson.
European portfolio managers who had sold dollars to protect against currency losses on US assets may now buy those dollars back, he said.
In other trading, the yen rose to ?122.47 per dollar, from ?122.58 yesterday, and to ?107.41 per euro, from ?108.12. Against the euro, the yen reached as strong as ?106.77, its sturdiest since ?106.66 on April 18.
The yen gained about 1 percent this week against the euro, after a 2.3 percent rally last week.
Record support for the administration of Junichiro Koizumi, Japan's new prime minister, has sparked enthusiasm that the government may be able to carry out plans to push banks to write off bad loans and other steps to revive growth.
Foreign investors have funneled funds into Japan in recent weeks, including purchases of yen.
Foreigners bought a net ?427 billion (US$3.5 billion) in Japanese stocks last week, the seventh straight week of inflows and the biggest one-week surge since December 1999.
The yen has fluctuated between about ?120 per dollar and ?125 per dollar for much of the past two months, and Bank of Tokyo Mitsubishi Ltd. expects that range to hold for the next three months.
Japanese investors' dollar purchases will likely prevent a decline below the ?120 level, Bank of Tokyo Mitsubishi's currency analysts in London wrote. The US currency probably won't rise past ?125, though, as Japanese exporters sell dollars and foreign investors buy yen, they wrote.
Volatility in the yen against the dollar, a reflection of demand for buying options to hedge against swings in the exchange rate, fell today to 10.175 percent on three-month maturities.
That's the lowest volatility level since Nov. 29, just as the dollar was on the verge of breaking out of the ?105-?110 range it had been confined to for most of last year.
In other trading, the US currency rose against the British pound to US$1.4186 per pound from US$1.4220, against the Swiss franc, to SF1.7509 from SF1.7424, and against the Canadian dollar at C$1.5498 from C$1.5431.
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