The dollar rallied on Friday after a slew of economic data reinforced the view that the Federal Reserve will most likely raise US rates at least once more this year.
In addition, the market is girding itself for next week's heavy US data calendar, which includes the March employment report, which some people think could make or break another rise in borrowing costs to 5.0 percent.
Rate expectations in the United States and the euro zone remain the overarching theme in the currency markets. So when two gauges of regional US business activity beat forecasts, the dollar got a boost against the euro and the yen.
"The US and eurozone are raising rates and the question of how long they raise rates, how much they raise rates and where the top is, is one that is endlessly debated," said John McCarthy, director of foreign exchange trading at ING Capital Markets in New York.
"The dollar and the euro, strangely enough, are being rewarded," he said.
By late afternoon, the euro was at $1.2115, down 0.4 percent, having touched one-week highs earlier in the session. On Thursday, the euro posted its biggest one-day gain against the dollar in two months.
Against the yen, the dollar was up 0.3 percent at 117.66 yen.
Earlier, the government reported inflation rose at a slower pace in February than in January, while consumer spending also eased. Separate reports showed consumer sentiment picked up sharply in March, and business activity in the auto-intenstive Midwest proved much more robust than expected.
"If the economy keeps expanding, if commodity prices go up and unemployment drops and jobs are created, it's not likely the Fed will stop raising rates. I think it's premature to say the US is done," ING's McCarthy said.
Next Friday, the government releases the March non-farm payrolls report. It is expected to show 198,000 workers were added to US payrolls, down from 243,000 the month before.
Despite its rebound on Friday, sentiment has been shifting against the dollar with the European Central Bank expected to raise its euro zone base interest rate to 3.25 percent in 2006 from the current 2.50 percent, narrowing the interest rate differential with the United States, analysts said.
The ECB meets on Thursday to discuss monetary policy.
The dollar is on track for its largest quarterly decline since the fourth quarter of 2004, when the euro reached record highs and the dollar dropped to five-year lows.
"We have had building expectations for ECB tightening and interest rate spread moving in favour of the euro zone," said Todd Elmer, currency strategist with Citigroup Global Markets. "That means it will be difficult for euro/dollar to sustain lower levels from here on out."
Matt Kassel, currency strategist with IDEAGlobal, noted the levels at which central banks have expressed interest in buying euros has moved higher recently, signalling strengthening demand for the currency.
"When the bar rises again and the short-term spot market takes euro/dollar above $1.2215, the game will be over on medium-term direction, and real money funds and peripheral sovereign interest will pick up the pace in general dollar selling," he said.
Rising US interest rates have been a pillar of support for the dollar for more than a year, with the federal funds rate now at 4.75 percent following a quarter-percentage point rate rise on Tuesday.
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