FOREX-Dollar bounces back from steep sell-off with more strength seen

Fri Jul 12, 2013 9:39am EDT

* Dollar rises on view that U.S. will still be first to halt stimulus

* U.S. growth outperformance to support dollar

* U.S. inflation data shows increase in price pressures

* Investors cautious before Chinese GDP data, Aussie falls

By Julie Haviv

NEW YORK, July 12 (Reuters) - The dollar was the market's darling on Friday as investors bought back the U.S. currency, confident that the Federal Reserve will be the first of the major central banks to step away from ultra-loose monetary policy.

The greenback had been reeling since U.S. Fed chief Ben Bernanke cast doubts on Wednesday over when the central bank will start slowing its asset purchase program, causing the dollar to retreat from a three-year high against a basket of six currencies reached earlier in the week.

The Fed's bond buying program is largely seen as negative for the dollar as it is tantamount to printing money, but the U.S. economy is on a much firmer footing than most of the euro zone, Japan and Britain.

Data on Friday showed U.S. producer prices rose more than expected in June, pointing to an apparent increase in inflationary pressures that could make the U.S. Federal Reserve more comfortable about reducing its monetary stimulus.

"There is some argument for suggesting that the shock effect of a dovish Bernanke has largely been digested," said Alan Ruskin, global head of foreign exchange strategy at Deutsche Bank in New York.

"Even if he tries to avoid changing his tone any policy surprises are more likely to be in a positive dollar direction than the reverse," he said.

Bernanke said on Wednesday that a highly accommodative monetary policy would be needed for the foreseeable future, pouring cold water on investor expectations that the Fed would start unwinding its stimulus programme in September and tighten policy in late 2014.

In early New York trade, the dollar index rose 0.5 percent to 83.158, although it was still down on the week. The dollar was up 0.6 percent against the yen at 99.48 yen.

"We are still structurally bullish dollar across a range of currencies including the euro and sterling," said Chris Walker, a currency strategist at Barclays.

The dollar had previously been gaining on the back of rising U.S. Treasury yields and widening interest rate differentials in its favour.

"What we saw this week was a washout of long dollar positions, but also a realisation that Fed tightening is still some way out. It's tapering of stimulus that will come first," said Walker, adding that high-yielding currencies such as the Australian dollar would lose more ground in coming weeks.

Traders are also cautious about the commodity-linked Aussie before the release of Chinese growth data on Monday. The Australian dollar was down 1.7 percent at $0.9034.

Analysts forecasts' point to China's economic growth slowing modestly to an annual 7.5 percent in the second quarter , but many economists see downside risks after a run of disappointing data.

Next week could also see solid U.S. retail sales and housing data that would again highlight the growth divergence between the United States and its peers the euro zone, Britain and Japan.

"We believe that the dollar's setback after the policy events of the past week is likely to remain limited and that a durable multi-year recovery is still in the early stages of development," Morgan Stanley strategists said in a note.

"Indeed, we see the current correction as a renewed opportunity to establish bullish medium-term positions," the firm said.

The European Central Bank, the Bank of England and the Bank of Japan are all looking to ease monetary policy further. On the other hand, an outperforming U.S. economy should support expectations that the Fed will be the first to pare some of its stimulus this year.

Against the dollar the euro was down 0.5 percent at $1.3024 .

The euro was weighed by comments made by one of the ECB's top policymakers, Peter Praet, that the bank will keep interest rates at current levels or cut them even further, as long as inflation remains moderate.

Also weighing on the single currency were Portuguese bond yields, which climbed after Lisbon delayed its creditors' next review of the country's bailout due to a political crisis, bucking the wider trend towards lower yields in other euro zone debt.