TOKYO (Reuters) - The dollar hit an 11-month high against the yen and 1-month high on the euro on Wednesday, extending its gains after a modest brightening of the Federal Reserve's economic forecasts nudged traders to downplay expectations of further monetary easing.
U.S. 2-year Treasury yields hit a 7-1/2-month high after solid retail sales data, making the dollar less attractive as a funding currency for carry trades. Tokyo exporters were also reluctant to sell it now, expecting more strength, traders said.
These factors saw the dollar hit a session high at 83.32 yen, its highest level since mid-April, with most traders expecting a short correction soon, before refocusing on last year's high at 85.53 yen.
"The move in the yields was essential for the dollar rally to continue," said Sumino Kamei, senior currency analyst at the Bank of Tokyo-Mitsubishi UFJ in Tokyo.
Recent easing steps by the Bank of Japan, the country's trading deficit amid surging demand for fossil fuels in the wake of the nuclear crisis have also helped the dollar rise a staggering 9 percent on the yen since the beginning of February.
"We are getting to a point where people will be looking for a trigger to take profits on this rise. There aren't many scheduled events that could prop it further, while risks -- most notably elevated oil prices -- loom large."
But investors said that a pullback in the dollar would likely be limited to the mid-82 area with the previous high of 82.65 lending support. Longer term, they were mostly bullish, with Barclays Capital raising its three month target to 88 yen.
The U.S. unit gained also against all other currencies, with its index hitting a 7-1/2-week high of 80.42 .DXY.
Hot on the heels of Friday's encouraging U.S. jobs report, a strong 1.1 percent rise in retail sales provided fresh evidence of improvement in the world's largest economy.
Acknowledging this trend, the Fed slightly upgraded its outlook, expecting "moderate" growth over coming quarters and a gradual decline in the unemployment rate, although it said the jobless rate "remains elevated.
"There is nothing for risky assets not to love about the Fed stance; either the economic outlook will continue to improve, or the Fed will take action to inject more liquidity into markets," said Julia Coronado, BNP Paribas chief economist for North America.
ZEW, equities, GDP: link.reuters.com/cag54s
Components of U.S. GDP: link.reuters.com/fan36s
U.S. retail sales: link.reuters.com/dew96s
Providing further comfort to the bulls, the Fed's annual stress test showed the majority of the largest U.S. banks passed, bolstering strong gains across most global bourses.
The inverse relationship between the dollar and equity markets has all but broken down and analysts expect this can persist.
"A part of the explanation is the very low starting point of expectations in early 2012 for U.S. growth and forward rates," said Jens Nordvig, global head of foreign exchange strategy at Nomura Securities.
In the past, investors tended to sell the dollar to buy higher-yielding assets on any upside surprise in key U.S. data. Now, strong numbers are seen as lengthening the odds of more action from the Fed, which is positive for the dollar.
"Another part of the explanation is that the ECB's LTRO operations have changed EURUSD trading dynamics. In a way, the euro is the new dollar, with potential to become the favorite funding currency in global capital markets," he said.
Reflecting this view, the euro fell some 40 pips to $1.3037, triggering stop losses below support at $1.3054, the 50 percent retracement of the Jan 16-Feb 24 rally.
Further support looms at the next major trough on daily charts at the February 16 low of $1.2974, and the 61.8 percent retracement of the January to February rally at $1.2954.
The Australian dollar also fell against the U.S. unit. It was down 0.3 percent at $1.0505, inching closer to the seven-week trough of $1.0473 plumbed on Monday.
In Europe, euro zone industrial production for January and inflation data for February are due later in the day.
Additional reporting by Ian Chua in Sydney, Hideyuki Sano in Tokyo and Masayuki Kitano in Singapore; Editing by Jacqueline Wong