FOREX-Dollar index hits nearly 3-year high, euro hits 6-week low
* Dollar index hits nearly three-year high
* Euro weighed by ECB negative rate cut talk
* San Francisco Fed's Williams says Fed could end QE this year
* Dollar/yen near 4-1/2-year high
By Julie Haviv
NEW YORK, May 17 (Reuters) - The dollar soared against a basket of currencies on Friday, reaching a nearly three-year peak as debate over whether the Federal Reserve would wind down its asset buying program later this year gathered pace.
The dollar's strength was largely attributed to the euro, which fell to a six week low on expectations the European Central Bank could introduce negative deposit rates, the rate at which banks park surplus funds with it.
The dollar index, which measures its value against a basket of six major currencies, rose to 84.214, its highest in nearly three years. It last traded at 84.184, up 0.7 percent on the day.
"People are positive about the U.S. economic recovery despite recent weak data and today's theme is mostly about the broadly strong dollar," said Charles St-Arnaud, FX strategist at Nomura Securities.
"Meanwhile, data in the euro zone shows they remain in a recession and raised expectations the ECB will take further action is weighing on the euro," he said.
The euro fell as low as $1.2814, its lowest since April 4. It last traded at $1.2824, down 0.4 percent on the day.
Against the yen, the euro was at 131.28, down 0.3 percent.
The euro was hurt by talk that the ECB was checking banks' preparedness to handle a potential cut in its deposit rates to below zero.
"The negative deposit rate talk is a threat that the ECB is using to keep the euro lower," said Ian Gunner, portfolio manager at Altana Hard Currency Fund. "I doubt with the Bundesbank on board, the ECB will implement it."
Lowering the deposit rate to negative would make holding euros unattractive and lead to a broad sell off, traders say.
ECB board members Joerg Asmussen and Benoit Couere said that monetary policy will remain accommodative, bolstering a view the central bank could use unconventional measures like introducing negative deposit rates in coming months to support the recession-hit economy.
DOLLAR NEARS 4-1/2 YEAR HIGH VERSUS YEN
Investors added to favorable bets on the dollar, drawing support from comments by a regional Federal Reserve chief who said the Fed could begin easing up on stimulus this summer.
John Williams, the president of the San Francisco Fed, said the U.S. central bank could completely exit its easing by the end of the year.
Although Williams is not a voter this year at the Federal Open Market Committee, his views carry weight as they are often considered close to those of top Fed officials such as Chairman Ben Bernanke and Vice Chair Janet Yellen.
Bernanke and Yellen want to keep monetary policy ultra-loose for a longer period of time, while others like Richmond Fed chief Jeffrey Lacker say the economy's prospects are looking better and the pace of asset purchases can be reduced.
"His comments took the market by surprise since he is a dove," said Peter Kinsella, currency strategist at Commerzbank.
"It is a dollar story this year as the U.S. labor and housing markets appear to be recovering. And while we do expect the Fed to be cautious in withdrawing stimulus, the economic recovery should drive the dollar higher."
The dollar last traded at 102.48 yen, up 0.2 percent and not far from Wednesday's 4-1/2-year high of 102.76 yen with investors taking Japanese Prime Minister Shinzo Abe's latest growth strategy into their stride.
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