Watch for the Federal Reserve's big decision this week

Euro

The dollar was on the defensive at the onset of the week as speculation the United States would ease interest rates heated up following weaker-than-expected consumer sentiment data.

Focus is shifting back to U.S. fundamentals, with the market keenly speculating on the amount of a possible rate reduction at the Federal Reserve's Open Market Committee (FOMC) meeting due to begin on June 24. Results of the two-day meeting are expected on June 25.

The University of Michigan reported its gauge of consumer sentiment slipped to 87.2 in June from the previous month's 92.1, contrary to economists' predictions that the figure would rise. The euro regained strength, with a record high above $1.1935, but was driven back by profit-taking.

Meanwhile, the European Central Bank board Ernst Welteke said the recent dollar depreciation might help the United States control its current account deficit.

However, the following day, the dollar regained composure boosted by a strong regional U.S. manufacturing report, which hit shortly after the sour consumer sentiment data.

The New York Federal Reserve's Empire State manufacturing survey, which is often overlooked by the market, far exceeded expectations, rising to a record high of 26.8 in June from 10.8 in May. Respondents voiced optimism on the sector's outlook, helping send major stock benchmarks sharply higher and underpinning the dollar.

The dollar continued to advance against the euro after data on consumer prices dampened speculation that the Fed will cut interest rates aggressively, leaving traders anticipating a shallower trim. In recent months analysts have grappled with concerns that the United States would suffer a sustained fall in prices that could force the Fed to lower borrowing costs by as much as half a percentage point to stimulate a sagging economy.

These fears were allayed, when the government reported that consumer prices were unchanged in May after falling 0.3 percent in the prior month. Excluding food and energy costs, "core" prices rose 0.3 percent in May.

The dollar see-sawed once again extending losses this time after a closely watched measure of the US manufacturing sector deflated market hopes for an imminent economic rebound. The Philadelphia Federal Reserve's index of manufacturing activity in the mid-Atlantic region showed growth for June, with the headline figure rising to 4.0 from -4.8.

But the figure fell far short of a more encouraging number factored in by many market participants. However, the dollar soared once again on the last trading day of the week hitting its highest level in a month against the euro on a shifting interest rate outlook and growing expectations of a US economic rebound.

Analysts expect that any reduction in interest rates will be supportive of growth in the world's largest economy, eventually helping the dollar even as the yield differential between assets of the United States and their higher-returning European counterparts widens.

A Reuter's survey of dealers who trade directly with the Fed showed a deep division over how aggressive the Fed will be. The poll, found the camp expecting a 50 basis point cut edging out those who see a smaller 25 basis points move by 12 to 9. The dollar capitalised on economic benefits of a likely rate cut, pressing to a new session high of $1.1552 to the euro.

Next week sees a slew of US data, which includes consumer confidence numbers, durable goods, home sales data, first quarter GDP figures, and personal income and spending data. In the eurozone, German IFO business sentiment index will attract attention.

Range for the week: $ 1.1400 - $1.1900


Japanese Yen

The dollar found support against the yen, as markets remained nervous about selling the dollar following a fresh verbal warning from Japan's top financial diplomat Zembei Mizoguchi.

izoguchi said that the yen was in no position to strengthen in the longer term. He also said the US economy remains strong relative to Europe and Japan. The dollar rose to 117.60 as talks swirled that the Bank of Japan had sold its currency to stop the dollar from trading below 117.00 yen.

Japan has sold yen for dollars in heavy doses a number of times this year to protect its exports, seen as essential for the nations economic recovery.

Midweek, the yen dropped further as Japanese government bond prices fell sharply, stirring fears that banks could run up big losses on their bond holdings that could ultimately hurt their economy. However, active selling by Japanese exporters around the high of 119.00 levels helped the yen recover marginally.

In the coming week, the yen is likely to trade within well-defined ranges with market attention on the Fed meeting.

Range for the week: 116.00 -121.00.


Sterling

The UK pound set a six-week high on the euro while retreating about a cent from recent 4 ½ year high versus the dollar as continued investor demand for attractive UK yields was partly offset by a dollar rise.

Sterling had initially tested a 4-½ year peak versus the dollar as Bank of England's Stephen Nickell played down the impact of the UK government's intended switch in the Bank's inflation target.

Nickell, who is on the Bank of England's monetary policy committee, said a change to the eurozone's Harmonised Index of Consumer Prices (HICP) inflation target would have no effect on monetary policy.

Markets had expected the BoE might adopt easier monetary policy if Britain switched its inflation target to the HICP. Sterling retreated against the greenback on the last trading session as the dollar bounced across the board on the view an expected US interest rate cut would support economic growth.

The market, which has long been focused on interest rate differentials, was waking up to the possibility an easing could be growth and equities boosting and hence dollar supportive.

Britain sees a relatively thin data week. But the outlook for British rates could resurface with Bank of England Governor Eddie George and other rate setters to appear before the treasury select committee on Tuesday.

Range for the week: $ 1.6400 - $ 1.6900.