FOREX-Euro rises; ECB hawkish despite soft German CPI

(Changes byline, updates prices, adds comment)

By Toni Vorobyova

LONDON, April 28 (Reuters) - The euro rose versus the dollar on Monday after European Central Bank policymakers continued to warn of upside inflation risks even as data showed consumer prices falling in five German states in April.

ECB President Jean-Claude Trichet and Governing Council member Yves Mersch both said risks to price stability remained on the upside, with Trichet adding that there were no grounds for complacency.

Their comments suggested the ECB is not ready to start cutting interest rates from 4 percent soon, even with regional data pointing to a likely negative monthly reading on German inflation for April.

"For the time being, the ECB remains on a fairly hawkish bias -- not arguing for higher rates, but certainly not allowing speculation that they are changing their mind (and cutting) any time soon," said Michael Klawitter, currency strategist at Dresdner Kleniwort in Frankfurt.

He added that German prices were affected by Easter -- and the related spending and holiday boom -- coming in March rather than April, and that inflation would likely rebound in May.

German national data is due later on Monday, followed by the figure for the euro zone as a whole on Wednesday.

By 0944 GMT, the euro was up 0.3 percent at $1.5668, though still more than 3 cents below last week's record high EUR=.

The euro also added 0.25 percent to 163.62 yen EURJPY=.

A surprising jump in a German consumer sentiment gauge [ID:nBAE001184] also helped the euro, suggesting that the euro zone's biggest economy may not be in as bad a shape as indicated by a weak Ifo business confidence gauge last week.

Meanwhile, rising commodity prices -- with oil hitting a new record high CLc1 -- kept the dollar on the back foot.

FED SHIFT?

However the euro's gains versus the dollar were capped by speculation that the U.S. Federal Reserve could indicate it may be approaching the end of its cycle of drastic interest rates on Wednesday, after delivering one more cut to 2 percent.

Such bets helped the dollar hit a two-month high of 104.82 yen JPY=.

The Fed has slashed borrowing costs by 3 percentage points since September in response to the credit crisis that erupted last year, but some speculate that climbing fuel and food prices could put the brakes on any more big cuts.

U.S. short-term interest rates futures are even indicating a 20 percent chance the Fed may hold rates at 2.25 percent this week FEDWATCH, rather than cutting them.

However such pricing leaves the dollar vulnerable to a potential sharp correction if the Fed remains dovish.

"Rate cut speculation has been scaled back considerably over the last days," Commerzbank Corporates & Markets said in a note.

"Hence, if the FOMC statement ... shows that the Fed's focus is still on downside risks to growth on the backdrop of rising unemployment and dwindling private consumption and therefore sounds rather dovish to the market, we see considerable potential for renewed Fed rate cut speculation, which would put the dollar under strong selling pressure." (Editing by Mike Peacock)