Major rally for the US dollar

The dollar responded with a series of three-month highs against the yen and two-week highs against the euro. Even a sharp fall in consumer confidence, as measured by the Conference Board's closely watched survey, failed to dent the market optimism seen early in the week.

Monetary policy meetings of the Bank of Japan and Bank of England next week are likely to result in unchanged rates, with recent data out of both Japan and Britain pointing towards improved economic conditions.

Euro

The euro kicked off with market trading cautiously in anticipation of good economic numbers from US in the later half of the trading week. Also aiding the US dollar was unwinding of long euro position ahead of a key German Ifo business sentiment survey.

But euro failed to capitalise on upbeat economic data that showed Germany's Ifo business climate index rose for a third straight month in July to 89.2, its highest level in a year, from 88.8 in June. But July's reading was below expectations.

The Fed's Beige Book suggested the economy is improving with most districts noting "somewhat stronger growth" in June and the first half of July and a more positive outlook for the period ahead. The report compiled by the Richmond Fed on data prior to July 21 said that activity in the manufacturing, services and energy sectors was stronger.

However, consumer spending emained "lacklustre." Housing starts and sales were strong in June and early July while commercial real estate remained sluggish and demand for commercial loans was weak. Residential mortgage loans demand was still spurred by low mortgage interest rates, the report said. Price and wage inflation remained "broadly in check."

Midweek, greenback's bullish momentum was briefly interrupted by an unexpected tumble in consumer confidence. The US Conference Board's consumer confidence index showed a drop to 76.6 in July from 83.5 the previous month. Economist had expected a reading of 85.0.

Prior to the confidence report, US Treasury Secretary John Snow reiterated his support for a strong dollar in an interview with a US television network.

After the release of the consumer confidence number upbeat comments by Dallas Federal Reserve President Robert McTeer gave the US dollar additional boost. He said the reasons to believe in an economic pick up are numerous and that a fall in consumer confidence was no cause for concern. McTeer had been dovish on the dollar until recently.

The dollar shot higher against major currencies, lifted by market hopes for strong U.S. economic data later in the week. The U.S. economy came back to life in the second quarter, according to preliminary figures released by the government, in part because military spending rose at the highest three-month rate since the Korean War.

In its first estimate of second-quarter gross domestic product, the Commerce Department said the economy grew at a 2.4 percent annual rate in the April-June period. That rise was well above the 1.5- percent rate of increase most Wall Street economists had been forecasting.

US Midwest manufacturing activity improved more than expected in July. The NAPM - Chicago index rose to 55.9, its highest level since January, from 52.5 in June. Economists had expected a reading of 54.0. Any reading above 50 indicates expansion.

In Euro land, the Bundesbank said it had not sold any of its US agency debt holdings recently after much speculation in the market that euro zone central banks had been selling US mortgage financing agency paper on the European Central Bank's advice.

The news was analysed as being dollar supportive. Data from euro zone was mildly encouraging for the euro, with French business confidence rising marginally in July. Research group GfK also predicted that German consumer sentiment would improve in August.

U.S. employers cut thousands of jobs in July, the government said on Friday, defying expectations that payrolls would grow, but a decline in the labour force sent the unemployment rate down. The jobless rate fell to 6.2 percent from 6.4 percent in June, the Labour Department said. Economists, on average, expected the rate to fall to 6.3 percent, according to a Reuters' poll.

But non-farm payrolls fell by 44,000 jobs, the report said, after losing a revised 72,000 jobs in June. Economists, on average, expected payrolls to grow by 18,000 jobs, according to Reuters. The two numbers moved in opposite directions because they are generated by separate surveys, and the unemployment rate fell mostly because the size of the labour force -- the number of working-age people either working or looking for work -- shrank by 556,000 people in July.

The recent market focus on falling bond prices has prompted renewed interest in the relationship between the dollar and bonds. At its best, the dollar clawed back nearly 4 cents, or about 3 per cent against the euro. But the upbeat mood moderated yesterday after non-farm payrolls showed that a soft labour market remained a sticking point for recovery hopes.

Moreover, a firm rise in manufacturing activity was still less than investors had hoped for. While few strategists deny that the US economy is showing at least tentative signs of recovery and is clearly outperforming the struggling euro zone, many are concerned about the sustainability of an economic pick-up and its consequences for the dollar

Range for the week: $1.1050 - $1.1550

Yen

Japan started the week with the release of employment data, the jobless rate eased in June to 5.3 percent from 5.4 in May, beating economist's forecast for a 5.4 percent.

There was nothing specific to yen's weakness, but perhaps the idea that the Bank of Japan has made good on its threat to intervene in the currency market.

The Ministry of Finance said that Japan sold 2.027 trillion yen ($ 16.86 billion) in the currency market in July to prevent the yen from appreciating sharply. So far this year, Japanese intervention has hit a record of around 9 trillion-yen.

As the week progressed US dollar broke key resistance levels on the back of good US economic numbers and headed towards the physiological level of 120.00 yen. But 120 level met some stiff resistance from Japanese exporters who were rumoured to be looking for a chance to sell before the mid-August summer holidays.

Investors flashing "buy dollar" signal finally managed to push the dollar above 120 yen on the back of strong US economic numbers. Japan's top financial diplomat Zembei Mizoguchi said that the yen was not set to strengthen against the dollar, judging from US economic fundamentals.

Japan also had good news on its manufacturing sector, although the impact was limited. The Reuters/Nomura/JMMA Purchasing Managers survey showed manufacturing activity in Japan expanded at its fastest pace in a year in July, rising 51.1 from 50.4 in June.

The yen also fell back before the dollar's advance, but trading in the pair was volatile compared with the euro's moves, with the yen and the dollar buffeted by opposing capital flows.

While Japanese institutions appear to be putting fresh money into US Treasuries as yields rise, international equity investors appear equally keen on putting funds into the Japanese stock market. By the end of the week US dollar had touched a high of 120.69 yen.

Range for the week: 117.00 - 122.00

Sterling

At the start of the week, sterling was on the front foot against the euro and dollar largely in a technical move as a lull in Britain's political and economic calendar encouraged investors to reverse bets against the currency.

As the week progressed sterling gave way to the broadly stronger dollar as anticipation of favourable US data buoyed the greenback across the board. Trading was so dominant by movements in the euro/dollar that an improvement in both British consumer confidence and retail sales failed to lift sterling even against the euro.

The July Charted Institute of Purchasing and Supply/Reuters' Purchasing Managers' Index for manufacturing rose to 50.9, it's highest level since May 2002, from June's upwardly revised 49.5. The news marked a return to growth in the sector for the first time in nine months and helped push sterling to a two-week high against the euro.

Recent UK data has been suprising on the upside, especially on the consumer side, forcing markets to scale back interest rate cut expectations. The Bank of England cut interest rates last month to 3.5 percent and recent retail sales and consumer borrowing data means most economists think interest rates have hit their floor in the current cycle.

Range for the week: $1.5950 - 1.6450