Dollar bolstered by Obama stimulus plan, ECB outlook

NEW YORK (Reuters) - The dollar posted sharp gains against the euro and yen on Monday, buoyed by a planned U.S. stimulus package and increased expectations of interest rate cuts by major central banks other than the Federal Reserve.

Investors welcomed news that U.S. President-elect Barack Obama is seeking as much as $310 billion in tax cuts as part of a proposed stimulus package that could be worth up to $775 billion.

"The combination of tax cuts, infrastructure spending and job creation under the Obama stimulus package takes out some of the pain from the economic recession we're in," said Ron Simpson, director of currency research at Action Economics in Tampa, Florida.

"The Federal Reserve and U.S. Treasury are being pro-active in dealing with this crisis. I think at some juncture, the U.S. efforts would turn the economy around quicker than many of the other countries and that should be dollar-positive," he added.

The yen, on the other hand, fell to more than three-week lows against the dollar amid improved risk appetite, with bargain prices and hopes for a global economic recovery this year prompting stock market gains in Europe and Japan.

The euro, meanwhile, hit three-week lows against the dollar, with weaker-than-expected inflation data in Italy and Spain and tax cuts in Germany seen raising pressure on the European Central Bank to cut interest rates further.

Analysts said the euro's rally in December was too far, too fast given the feeble state of the euro zone economy.

In late New York trading, the euro weakened 2.1 percent on the day to $1.3587, after earlier touching $1.3548 -- its lowest since mid-December, according to Reuters data.

Against the yen, the dollar climbed to 93.56 yen, according to Reuters data, its highest since December 8. It last traded at 93.29 yen, up 1.2 percent. The Japanese currency surged nearly 19 percent last year against the dollar as investors sold off risky assets financed with the yen's cheap rates.

Sharp losses by the euro have also helped sterling recover some of its recent losses against the euro zone currency. Last week, sterling hit record lows against the euro and appeared to be headed for parity.

The euro fell sharply against the pound to 92.44 pence. It earlier hit 92.29 pence, according to Reuters data, also the lowest since mid-December.

The euro weakened after ECB Vice President Lucas Papademos said on Sunday that more rate cuts may be needed to shield the euro zone economy from recession.

"His comments have dented some of the euro's appeal by suggesting that lending rates could fall aggressively in the coming months, which is a bit of an about-face from recent remarks by other ECB officials, who had suggested a resistance to cut rates as aggressively as the U.S.," said Omer Esiner, senior market analyst at Ruesch International in Washington.

EURO ZONE WOES

Figures on Monday showed Italian EU-harmonized consumer price growth slowed in December while similar Spanish data showed inflation tumbled to a 10-year low.

These numbers add pressure on the ECB to cut rates further when it meets next week to decide on monetary policy in the currency bloc. Markets have largely priced in a half percentage point rate cut to 2 percent.

Investors also see the probability of borrowing costs falling more sharply to 1.75 percent.

"ECB President Trichet has played down the risk of deflation, describing the risk as just a temporary base effect, (but) monetary conditions are currently tightening," Bank of Tokyo-Mitsubishi wrote in a note to clients.

"Tightening conditions will force the ECB to act more aggressively than is currently expected, prompting a renewed drop in the euro/dollar rate," it said.