FOREX-Dollar rally fades but view on Fed taper intact
* Dollar supported by expectations for more Fed tapering
* WSJ says Fed may announce further tapering next week
* Euro slips after German ZEW survey
* Canadian dollar drops to four-year low vs U.S. dollar
* IMF raises global economic growth forecasts
By Daniel Bases
NEW YORK, Jan 21 (Reuters) - The dollar's early rally on Tuesday, which was sparked by a rise in U.S. Treasury yields on speculation the Federal Reserve would further reduce its bond-buying stimulus, ran out of steam for lack of follow-through buying, analysts said.
However, the overall trend for a stronger dollar is backed by improving economic fundamentals and generally higher interest rates.
"The trend is in line with what we have seen on a macro-economic level. I wouldn't read too much into one day's moves, because overall the trend of a stronger dollar remains intact," said Alvise Marino, currency strategist at Credit Suisse in New York.
Developed market currencies were given a boost after the International Monetary Fund raised its 2014 global economic growth forecast to 3.7 percent from 3.6 percent in October, its first increase in nearly two years.
Sterling gained 0.25 percent to $1.6470 following the IMF's forecast, which boosted Britain's growth forecast to 2.4 percent this year from the prior forecast of 1.9 percent. U.S. growth is now seen rising 2.8 percent rather than 2.6 percent.
The greenback climbed to its strongest level against the Canadian dollar in over four years. While the U.S. is on a path of reducing monetary stimulus from historic levels, expectations have grown that Canada's central bank is moving toward a path of looser monetary policy.
The Bank of Canada will release on Wednesday the results of its latest meeting, at which a Reuters poll of economists expects no change to the 1 percent benchmark interest rate.
"The clear focus is on the BOC policy meeting tomorrow. I think there is a fair bit of speculation, mainly from U.S. and European banks that we could get an easing bias from the Bank of Canada tomorrow. I don't think they are anywhere ready to go that far," said Shaun Osborne, chief currency strategist at TD Securities in Toronto.
"I think we have seen a fair amount of stimulus come into the economy from a weak Canadian dollar and there is just no rush at this point for the bank to make that step," he said, adding that the bank will likely want to keep its powder dry in order to keep the currency weak.
The U.S. dollar traded up 0.26 percent to C$1.0973. It broke through a reported option barrier at C$1.10 to hit a high of C$1.1019.
EURO RECOUPS GROUND, GERMAN SENTIMENT WEAK
The euro regained ground on the dollar, turning slightly positive on the day to trade at $1.3558 as U.S. Treasury yields drifted down, having earlier suffered after Germany's ZEW economic sentiment indicator for January came in below forecasts..
Market expectations remain for the European Central Bank to keep monetary policy accommodative and maybe even cut rates if money markets tighten.
"The focus is more on the ECB's liquidity operations, and unless that is addressed, we expect the euro/dollar to remain a pain trade, staying in a range," said Geoffrey Yu, strategist at UBS.
The dollar held its gains on the Japanese currency, rising 0.16 percent to 104.33 yen.
U.S. yields rose, and gave the dollar a boost, after the Wall Street Journal said the Fed may announce a further reduction to its monthly bond purchases at its Jan. 28-29 policy meeting, to $65 billion from the current $75 billion.
"The report is not all that surprising but it did get the 10-year yield to move higher; but it is now moving back down," said Osborne of TD Securities.
A reduction in the Fed's stimulus program would match the market expectations in a recent Reuters survey. Still, traders said the WSJ article helped to nudge the dollar higher against the yen.
"On the yen side, there is some positioning that the Bank of Japan may sound more dovish at the end of its policy meeting this week. We actually expect them to upgrade growth forecasts and that could actually see some correction in the dollar/yen in the short term. In the medium term, we expect the pair to rise," said Manuel Oliveri, FX strategist at Credit Agricole.
Key for the yen this week is the outcome of the Bank of Japan policy meeting on Wednesday. The BOJ is expected to retain a wait-and-see approach, having last year launched a massive stimulus program.