The euro hit one month highs versus the dollar and sterling on Wednesday after a surprise improvement in German business sentiment added to talk that the next move in eurozone interest rates may be up rather than down.
The speculation started on Tuesday after ZEW president Wolfgang Franz said he expects the European Central Bank to tighten policy soon from the current 4 percent. His comments were supported by higher than expected German producer price inflation and on Wednesday a surprise rise in the Ifo business sentiment index.
"The Ifo showed that the ECB is still in a position to make a move (up in rates) if it needs to do so," said Simon Derrick, head of currency research at Bank of New York Mellon. "That's what people are looking for - a central bank that is concerned more about inflation than anything else and has the flexibility to be able to deal with it should the need arise. And on both those counts the euro wins."
The euro rose as high as $1.5767 and 80.17 pence - levels not seen since April 24. It also hit a three-week high at 163.15 yen. The Ifo economic institute's business climate index came in at 103.5 in May, far exceeding forecasts for a dip to 102.0.
The euro's rally - as well as a rise in oil prices to fresh record highs - dragged the dollar down to a one-month low against a basket of six major currencies, at 72.040. In contrast to burgeoning speculation of an ECB rate hike, bets on a Federal Reserve tightening before the end of the year have faded over the last few days, in part thanks to comments from vice chairman Donald Kohn on Tuesday.
Kohn said US rates seem to be at the right level for now, but there was much uncertainty about the future outlook. "His rhetoric dovetails with our view that the Fed is likely not committed at all to any specific course for interest rate policy in coming months," Saxo Bank said in a research note. "This and the lower than expected (headline US) PPI release yesterday were dollar bearish as more hawkish expectations have been creeping into the forward expectations."
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