Dollar index edges higher after hitting 3-year trough

A one Australian dollar coin ($1.09) is seen in this picture illustration taken in Sydney April 29, 2011. The Australian dollar consolidated near recent highs against a broadly weaker U.S. currency on Friday and within spitting distance a huge chart objective at $1.1000, having enjoyed its best month so far this year.

NEW YORK (Reuters) - The dollar index edged higher on Monday after falling to a three-year trough, but is seen poised to move lower again as investors seek higher rates offered abroad and shun the low-yielding greenback.

News that U.S. forces killed al-Qaeda leader Osama bin Laden had a muted impact on the foreign exchange market, with investors remaining fixated on interest rate differentials.

The Federal Reserve is keeping monetary policy loose while other central banks, such as the European Central Bank and the Bank of England, have already raised rates or are on the verge of doing so. Australia and Canada are expected to tighten lending conditions in the months ahead.

Higher rates in Europe have undermined support for the dollar, boosting the euro by 11 percent so far this year. Sterling has gained 7 percent on the dollar.

The U.S. dollar index, which measures the greenback versus a basket of currencies, hit a three-year low of 72.722 earlier in the day, edging closer to the record low of 70.698 set in March 2008. It last traded up 0.2 percent at 73.046.

The euro climbed to a 17-month high above $1.49 after surprisingly strong manufacturing data bolstered chances that interest rates in the euro zone will rise further.

"The dollar's deteriorating yield appeal relative to its major counterparts is likely to keep it vulnerable as long as the Fed remains comfortable with its very low borrowing costs," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington.

In late New York trading, the euro was up 0.2 percent to $1.4834 after earlier rising as high as $1.4902, according to Reuters data.

Volatility was generally higher and should remain elevated this week given an ECB monthly policy meeting on Thursday and U.S. jobs data on Friday. But with the Fed firmly set on keeping rates low for an extended period, it would take very strong jobs data for it to change its assessment materially.

Steven Englander, head of G10 strategy at CitiFX, a division of Citigroup, in New York, said with the ECB not likely to raise rates until July, the big risk would be an indication that it would move sooner or move beyond 1.75 percent by the end of the year.

The ECB last month raised rates by a quarter of a percentage point, to 1.25 percent, its first rate hike since July 2008.

"At this stage, the euro remains very sensitive to rates, so the indication of an 'extra' hike would be very material, especially given the Fed's current orientation," Englander said.

One-month implied euro/dollar vols rose to around 10.95 percent on Monday, up from 10.6 percent late last week, but below 11.0 percent reached earlier in the week.

One-month EUR/USD risk reversals were around 0.75 in favor of euro puts, suggesting the premium to sell euros remains relatively low even as investors brush off euro zone debt problems and plow into the single currency.

Risk reversals have seen a limited move even as spot euro/dollar climbs higher, suggesting the risk of a sharp turnaround in the euro remains limited at the moment.

Analysts said any retaliation for bin Laden's killing could be positive for the dollar if it provoked a flight-to-safety bid, but added that it was unlikely for the moment.

"Bin Laden's death is seen as having little long-term impact on the U.S. dollar's broadly negative tone, which continues to be fueled by the Federal Reserve's very dovish monetary policy outlook," Commonwealth's Esiner said.

Against the yen, the dollar was flat at 81.20 yen while the Australian dollar hit a post-float high above $1.10 before easing to $1.0940 late in the day.

(Additional reporting by Wanfeng Zhou and Steven C. Johnson in New York; Editing by Dan Grebler)