Thursday, August 31, 2006

FOREX-Dollar edges up ahead of U.S. payrolls data

By Steven C. Johnson

NEW YORK, Aug 31 (Reuters) - The dollar crept higher on Thursday after a batch of U.S. economic data landed largely in line with expectations, prompting a bout of position squaring before Friday's keenly awaited U.S. employment report.

The Federal Reserve kept interest rates steady at 5.25 percent earlier in August, and policy makers have said slowing U.S. economic growth should moderate inflation pressures.

So payrolls growth that significantly deviates from the median forecast of 120,000 new jobs could alter the market's outlook on interest rates and sentiment on the dollar.

"Bear in mind that we have a big number (U.S. payrolls) tomorrow and we have a long weekend, so we aren't going to explode before that data," said John McCarthy, director of foreign exchange at ING Capital Markets in New York.

U.S. financial markets will be closed on Monday for the Labor Day holiday.

By late afternoon, the euro was down 0.2 percent at $1.2815 , off session lows of $1.2786.

Earlier, the dollar had slipped against the euro after European Central Bank President Jean-Claude Trichet signaled that the bank may have to raise interest rates soon to stem inflation in the euro zone.

With the market already positioned heavily in favor of euros, however, the dollar rebounded as traders squared up ahead of Friday's jobs report, a key release that could shed light on the direction of U.S. monetary policy.

Brian Garvey, senior currency strategist with State Street Global Markets in Boston, warned markets may be prone to violent moves if there is a wild swing in payrolls growth.

"We suspect economists have been lulled into a false sense of security over the stable trend in payrolls, which means markets should be more sensitive to a surprise in either direction -- even if the report is released on the Friday before the Labor Day weekend!" he wrote in a note to clients.

The market showed little reaction to comments from St. Louis Fed Bank President William Poole, who said Thursday that price stability must be the U.S. central bank's primary goal.

Separate remarks from Fed Chairman Ben Bernanke steered clear of monetary policy, focusing on productivity growth.

V FOR VIGILANCE

After the ECB held interest rates steady at 3 percent as expected, Trichet urged "strong vigilance" on inflation, seen by markets as a sign that rates are likely to rise again soon.

"The rate differential will continue to shift in favor of the euro and away from the dollar and the yen, and that's one reason you've seen the euro gain so much against the yen," said Michael Woolfolk, senior strategist at The Bank of New York.

The euro hit a record high against yen at 150.78 yen before easing to 150.35 yen , nearly unchanged on the day.

The dollar rose 0.3 percent against the yen to 117.37 yen , just below a one-month high of around 117.50 reached earlier in the session.

Many dealers have been frustrated by the market's inability to push the dollar out of narrow ranges this summer.

That could change, analysts said, pointing to Thursday's unexpectedly weak rise in the core personal consumption expenditure index, a key measure of U.S. inflationary pressures, as likely to weigh on the dollar.

The index rose just 0.1 percent in July, below market forecasts for an increase of 0.2 percent.

However, should U.S. jobs growth come in stronger than expected, the near-term direction for the euro could be down to the lower end of the $1.27-$1.29 range, Woolfolk said.

(Additional reporting by Kevin Plumberg)

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