FOREX-Dollar firmer on rate differentials

Mon Jun 24, 2013 3:44am EDT

Related Topics

* Dollar index rises to two-and-a-half week highs

* Fed's stimulus withdrawal plan drives U.S. yields up

* Chinese credit crunch risk also underpins dollar

* Weak German Ifo would weigh on euro

By Anirban Nag

LONDON, June 24 (Reuters) - The dollar extended gains against a basket of currencies on Monday to trade near its highest in over two weeks, boosted by expectations that U.S. monetary stimulus will soon be scaled back.

Federal Reserve Chairman Ben Bernanke said last Wednesday that the U.S. central bank could taper its monthly $85 billion in asset purchases if the economy continues to improve.

The dollar also gained support from risks of a credit crunch in China, which undermined growth-linked currencies like the Australian dollar.

The Fed chief's remarks helped push up the benchmark 10-year U.S. Treasury yield to its highest in almost two years in Asia on Monday with interest rate differentials moving in favour of the dollar and boding well for it.

The dollar index, was up 0.4 percent at 82.661 after rising as high as 82.742, its highest since June 5. The gains built on last week's 2.2 percent rally, its biggest weekly rise in 19 months.

The euro fell 0.2 percent to $1.3095 after dropping as low as $1.3078, a level not seen since June 6.

The common currency has given back about 50 percent of its mid-May to mid-June rally, bringing in focus support at $1.3034, which represents the 61.8 percent retracement of that advance. Before that, it has some support at its 200-day moving average of $1.3073.

Investors will watch out for the latest Ifo numbers from Germany at 0800 GMT. Given recent floods there, expectations of a significant improvement in the business climate reading are low.

"If we get a weak Ifo, we could see the euro drop below $1.3075 and then drop towards $1.30," said Peter Kinsella, currency strategist at Commerzbank. "The European Central Bank is expected to keep policy accommodative while the Fed has room for more flexibility."

Rate differentials between 10-year Treasuries and similar dated German Bunds have moved in favour of the former, with spreads at their highest since April 2010.

Against the yen, the dollar was up 0.6 percent to 98.40 yen after earlier touching 98.72 on the EBS trading platform, its highest since June 11.

Diverging policy outlooks between the Fed and Bank of Japan could push the spread wider between yields on the countries' bonds and in turn fuel further dollar gains, strategists said.

"The higher Treasury yields lead to a stronger dollar, of course," said Masashi Murata, senior currency strategist at Brown Brothers Harriman.

But higher U.S. yields could lead to risks of their own, as they threaten to weigh on lending and sap growth, Murata said. He added the yen could be bought back on such concerns and the dollar will likely be capped ahead of the 99-yen level for now.

On top of concerns about the impact of the Fed's exit plan, a recent spike in interbank borrowing costs have raised fears that stress in China's banking system could weigh on already slowing growth.

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