FOREX-Dlr index near 10-month high, ECB deposit rate cut talk hits euro

Fri May 17, 2013 7:26am EDT

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By Anirban Nag

LONDON, May 17 (Reuters) - The dollar rose against a basket of currencies on Friday, trading near a 10-month high as debate over whether the Federal Reserve would wind down its asset buying programme later this year gathered pace.

The dollar's strength, along with expectations that the European Central Bank could introduce negative deposit rates, the rate at which banks park surplus funds with it, kept the euro pinned down to recent six-week lows.

The dollar index, which measures its value against a basket of six major currencies, rose 0.42 percent to 83.935, nearing a 10-month high of 84.094 set on Wednesday. A break of its July peak of 84.10 would see it rise to its highest in nearly three years.

The dollar was up 0.15 percent at 102.35 yen, not far from Wednesday's 4-1/2-year high of 102.77 yen with investors taking Japanese Prime Minister Shinzo Abe's latest growth strategy into their stride.

Investors added to favourable 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, also 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. labour 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."

A resurgent dollar pushed the euro down to $1.2863, not far from a six-week low of $1.2843 hit on Wednesday.

The euro was also 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.

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