* Euro erases gains on report Weber out of race to head ECB
* Dlr up vs yen and Swiss franc as higher U.S. yields help
* Markets await Fed Bernanke’s testimony
(Recasts with euro, adds details, quote, details)
By Anirban Nag
LONDON, Feb 9 (Reuters) - The euro gave up its gains against the dollar on Wednesday after sources said Bundesbank head Axel Weber will not be a candidate to replace Jean-Claude Trichet as President of the European Central Bank.
The dollar also climbed against the yen and the Swiss franc on Wednesday, boosted by rising U.S. yields, while a sanguine reception from investors to China’s latest rate hike helped the Australian dollar stay above parity.
The euro EUR= fell to a session low of $1.3609 from around $1.3645 before the news and was last trading at $1.3633, flat for the day.
Weber, who had been considered a front-runner to succeed Trichet when his term expires in October, is regarded as a hawk on inflation but often finds himself in the minority. [ID:nLDE7180MQ]
“He had a fairly hawkish line, and these views may not have reflected the ECB’s and have not helped him,” said Steve Barrow, head of G10 currency research at Standard Bank.
“This news has come as a surprise to many, which is why the euro dipped. But it has held reasonably well, which suggests there is underlying support.”
The euro hit a three-month high of $1.3861 last week on mounting expectations the ECB would raise interest rates later this year. Those expectations were reined in after Trichet sounded less hawkish than many were expecting when the board kept rates on hold at its monthly meeting last week.
Still, investors are pricing in chances that the ECB will move to raise rates ahead of the U.S. Federal Reserve. Attention will turn next to Fed Chairman Ben Bernanke’s testimony at 1500 GMT to the House Budget Committee.
“We expect him to repeat his concerns over unsustainable U.S. debt trends, but also that low rates are appropriate for the time being,” said Chris Turner, chief currency strategist at ING.
Bernanke will be giving testimony as the U.S. 10-year Treasury yield hovers at nine-month highs US10YT=RR. That has moved yield differentials in the dollar’s favour and was lending it support, especially against the yen, traders said.
Against the Japanese currency, the dollar gained 0.3 percent to 82.60 yen JPY=, recovering from a fall to 81.77 yen on Tuesday. Traders say the dollar is unlikely to run much higher as some Japanese investors will have to buy yen ahead of a U.S. Treasury redemption and coupon payment on Feb. 15.
Some traders cite stops above 82.70 yen.
Traders said the tight correlation between U.S. yields and the dollar/yen pair was showing signs of re-establishing itself after having broken down earlier in the year.
Signs of a broadening U.S recovery and some hawkish commentary from Fed officials have contributed to higher U.S bond yields this week. Two-year yields have risen around 30 basis points over the last week.
“The rise in US yields seen over the past week, especially at the short end of the curve, are finally starting to feed through into support for dollar/yen,” BNP Paribas said in a note.
“A break through the initial trend line resistance at the 82.95 level will trigger a dollar/yen bullish signal opening upside potential towards 85.00.”
The dollar was up 0.2 percent on the Swiss franc at 0.9650 francs CHF= having hit a 2-1/2 week high of 0.9660. The next possible targets for the dollar include the 100-day moving average at 0.9691 francs and more importantly, its mid-January peak of 0.9784.
The euro hit a two-month high of 1.3179 francs EURCHF=, up 0.3 percent on the day, with risk appetite holding up reasonably well despite a hike by the Chinese central bank on Tuesday.
The markets have settled down since China delivered a 25 basis point rate hike late on Tuesday, the second increase in little more than six weeks. [ID:nL3E7D81F7]
The Australian dollar AUD=D4, highly sensitive to Chinese interest rate policy as China is the biggest market for its top exports, iron ore and coal, traded at $1.006 AUD=D4 with robust support at $1.0083, last Thursday's low. (Editing by Hugh Lawson)