The dollar hit a 28-month high above 120 yen on Thursday and the euro hit a one year peak versus the yen, as the single European currency found support ahead of an expected European Central Bank rate rise later in the session.
The euro was closing in on a lifetime high against the yen, holding firm as the ECB was widely expected to raise its key rate to 2.25 percent from the current 2 percent, the first rate rise in five years.
Dealers said the euro might lose traction however if ECB President Jean-Claude Trichet did not deliver a message that backed up views of many market players that the bank will press on with another two quarter-point rate rises in 2006 to stem inflation. The rate decision is due at 1245 GMT, followed by a news conference with Trichet at 1330 GMT.
"If he (Trichet) were to imply that is was a one-off rise then that would damage the euro but I don't think that's likely to happen. It will be a case of reading between the lines to see how confident he is on growth and inflation next year," Tim Fox, foreign exchange strategist at Dresdner Kleinwort Wasserstein, said.
European banks joined euro zone politicians, trade unions and businesses on Thursday in criticising the expected ECB tightening, saying it would hurt a fragile economic recovery in the region.
The dollar had risen as high as 120.05, its highest since August 2003, before trimming gains to around 119.80 by 1120 GMT. The euro was trading at 141.35 yen after soaring as high as 141.41, its highest in a year. The euro is now very close to a lifetime high above 141.60 yen. The euro was little changed against the dollar at $1.1781 but remained over a cent above 2-year low of $1.1638 hit last month.
A survey showed the euro zone's manufacturing sector picked up slightly in November from October, in line with economists' forecasts. The yen has suffered as expectations for an end to Japan's ultra-easy monetary policy, which keeps the cost of borrowing at virtually zero, have waned due to Japan's Ministry of Finance cautioning the Bank of Japan against a premature move.
"The general picture for the yen remains the same, it's the line of least resistance to the dollar in our opinion and more and more people are coming round to that opinion as well," Derek Halpenny, currency economist at Bank of Toyko Mitsubishi, said. Traders said that ahead of the ECB meeting, the euro was getting good support against the yen, with the euro's rate advantage over the Japanese currency set to widen.
The dollar has also been supported by a better yield. The Federal Reserve is expected to raise by 25 basis points this month and also in January, pushing the fed funds rate up to 4.5 percent.
The dollar has gained 10 percent against the yen and 7 percent versus the euro since early September.
Providing more fuel for dollar bulls, a report showed on Wednesday that the US economy grew by 4.3 percent in the third quarter, higher than the initial estimate of 3.8 percent and expectations for an upward revision to 4.0 percent.
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