December 11, 2013 / 3:16 PM / 4 years ago

FOREX-Euro gains for 7th day vs dollar as short-term rates rise

* Euro hits six-week high vs dollar again

* Higher money market rates lend support

* U.S. budget deal reached in Congress

By Gertrude Chavez-Dreyfuss

NEW YORK, Dec 11 (Reuters) - The euro rose for a seventh straight session against the dollar on Wednesday, driven by a combination of higher money market rates and a growing belief that the European Central Bank will keep interest rates low for some time but not cut them.

Overnight lending rates have been creeping higher the last few sessions, as banks have paid back long-term funding lent by the ECB at the height of the euro zone debt crisis.

In addition, the ECB’s unwillingness to ease monetary policy soon, despite inflation low enough to prompt talk of deflation, has seen a rise in two-year swap rates.

Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington, said higher short-term rates have indeed enhanced the appeal of the euro, but said much of the euro’s outperformance has been a function of investors reducing short positions.

Overall he said the euro zone still “faces a long road to recovery,” citing recent weak economic data. Payrolls in France, the euro bloc’s second largest economy, fell in the third quarter, while consumer prices in the leading German economy were at 1.3 percent year-over-year in November, well below the ECB’s inflation goal of just under 2 percent.

In early New York trading, the euro was up 0.2 percent against the dollar at $1.3788, after hitting a six-week high just shy of $1.38.

Against the yen, the euro was up 0.1 percent at 141.59 yen . It was up more than 23 percent versus the Japanese currency so far in 2013.

The euro has also been supported by European banks repatriating funds to shore up their capital bases before an ECB Asset Quality Review (AQR).

“There still seems to be decent underlying euro support,” said Simon Smith, head of research at FxPro. “We’re still seeing money market rates moving higher.”

He said the euro could hold “around the upper 1.30s level” early next year. It might weaken after the AQR, but Smith expects it to fall less against the dollar than other currencies when the Federal Reserve begins slowing its huge bond-buying program.

One-year risk reversals - which compare demand for options on a currency’s rising or falling - show a bias for euro puts, or bets that it will weaken. That suggests many speculators think the rally will not last.

The dollar, meanwhile, slipped 0.1 percent against a basket of currencies to 79.85, and fell 0.2 percent versus the yen to 102.59.

The greenback has weakened in recent sessions on the view the Federal Reserve will not reduce its economic stimulus until early next year. James Bullard, the St. Louis Fed president, however, has kept the window open for a small amount of tapering this month.

Still, when the Fed does decide to scale back its bond purchases, any upside for the dollar could be limited since that move has long been expected. Moreover, when the Fed does taper, it would be small comfort for the greenback as short-term interest rates are likely to stay low.

But one ray of hope for dollar bulls is a two-year budget deal in the U.S. Congress announced on Wednesday aimed at avoiding another government shutdown.

The Swiss franc, meanwhile, hit a seven-month high against the euro, which fell to 1.2201 francs. The euro was last little changed at 1.2217 francs

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