FOREX-Trichet's rate shocker keeps euro on firm ground

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By Veronica Brown

LONDON, June 6 (Reuters) - The euro built on hefty gains against the dollar on Friday after European Central Bank President Jean-Claude Trichet moved into ultra-hawkish mode, signalling a possible rate hike as soon as next month.

Trichet stunned markets on Thursday by saying a number of policymakers wanted higher interest rates and gave a clear indication that borrowing costs may rise by 25 basis points in July, lifting the euro sharply.

The remarks also caused short-dated euro zone government bonds to sharply underperform other maturities, briefly increasing a 2-10 year debt yield inversion to 30 basis points, its deepest since the euro's launch in 1999.

The Trichet comments doused this week's broad dollar rally, which gathered pace after Federal Reserve Chairman Ben Bernanke commented about the impact of dollar weakness on inflation [ID:nN04299230].

While the single currency reacted to the potential increase in yield in knee-jerk fashion, some analysts injected a note of caution into expectations for it to reach fresh record highs hit in April above $1.60, mindful of recent efforts to stem the dollar's decline.

"Yesterday's move was disastrous in terms of global cooperation. We had just got to the point with Bernanke talking up the dollar, with euro/dollar moving lower and oil prices $14 off their highs ... where people were believing there was a more coordinated global approach," said Nick Parsons, head of markets strategy at nabCapital.

He said the euro could struggle to make much headway above $1.5750, adding that recent data, including figures earlier showing that German industrial output had unexpectedly fallen [nL06531619], showed the region's slowdown was under way.

By 1101 GMT, the euro was steady at $1.5590 EUR= off an intraday high $1.5617, and more than 2 cents up from Thursday's three-week low of $1.5365.

The single currency climbed 0.3 percent to a five-month high of 165.70 yen EURJPY=R, also helped by solid gains in regional stocks which spurred carry trades, where investors sell the yen in favour of higher-yielding assets.

The dollar rose 0.2 percent to 106.16 yen JPY=, pushing back towards a three-month peak of 106.44 yen hit on Thursday.

PAYROLLS LOTTERY

The greenback might also see further pressure with a weak print from U.S. non-farm payrolls figures at 1230 GMT, but the spread of forecasts has been wide.

Economists polled by Reuters expect 58,000 jobs were shed in May, but traders are pointing to a slightly more positive consensus of -30,000.

This week's array of inflation-fighting comments from top central bankers showed heightened concern about containing the flare-up of price pressures from soaring oil and food prices, with crude now back above $130.

"Bernanke's comments earlier in the week with respect to the dollar suggests that broad valuations on the dollar may be used as a barometer on whether monetary policy has become too accommodative," said UBS in a note to clients.

NabCapital's Parsons said that, despite Trichet's rate signal, there would be a sustained effort from politicians and finance ministers at next weekend's G7 finance minister's meeting to talk euro/dollar down. (Reporting by Veronica Brown; editing by Stephen Nisbet)