Iraq fears limit US dollar rally

Euro

The dollar began the week trading higher against the European single currency amid a broad rally generated by last week's surprisingly robust U.S. jobs report for March.

The improvement in the U.S. jobs data is seen key to the U.S. Federal Reserve to raise its funds rate from a 1958 low of one percent, which would increase the allure of dollar-denominated assets for foreign investors.

The dollar buying momentum was bolstered further after the release of ISM service sector data that painted a brighter economic picture. The Institute for Supply Management's (ISM) non-manufacturing index surged to 65.8 in March, a 12th straight month of expansion, from 60.8 in February and with market's anticipation of 61.5.

Economic figures from euro zone on the other hand, weighed on the single currency. German jobless rose by a larger than expected 44,000 to 4.344 million in seasonally adjusted terms in March and the adjusted unemployment rate rose to 10.4 pct, while euro zone retail sales fell 0.8 pct in the month of February.

In addition, German industrial output tumbled 0.7 pct in February, unexpectedly posting its first drop in five months. Hans-Werner Sinn, head of Germany's Ifo Institute, stated that the euro zone's biggest economy is mired in a fundamental economic crisis.

Bad economic indicators from euro zone increased speculation that the European Central Bank might cut interest rates soon from 2 pct to boost Europe's flagging recovery. The European Central Bank, which left rates steady the previous week, told finance ministers that it was flexible and ready to change interest rates if needed.

As the week advanced, the dollar trimmed some of its gains on escalating violence in Iraq while fears of further militant attacks drove investors into safe-haven currencies.

Markets feared repercussions after the U.S. military bombed a mosque compound in the Iraqi town of Falluja and following a recent audio tape from Al Qaeda supporter exhorting followers to attack U.S. force in Iraq. Toward the end of the weekend, the dollar traded on a soft note in thin trade ahead of long Easter holiday weekend.

The week ahead will be dominated by U.S. inflation, retail sales and industrial figures as investors gauge the likelihood of U.S. interest rate hike. Inflation data is also due on the other side of the Atlantic from France and Italy and industrial production data from Italy will also be closely watched.

Range for the week: $1.1900 - $1.2300.

Japanese Yen

The Japanese currency started the week hovering around 104 levels against the dollar as steep gains in Tokyo share prices fuelled demand for the yen from foreign investors.

In addition, the yen strengthened after an upgrade of Japan's foreign currency debt reaffirmed growing optimism about the Japanese economy. News that Moody's had raised its rating on Japan's foreign currency-denominated debt came as little surprise to many investors already bullish on investment opportunities.

Moody's cited Japan's ballooning foreign reserves as a reason behind its upgrade to Aaa from Aa1. Japan's reserves hit a record high of $826.577 billion at the end of March due to aggressive currency market intervention to weaken the yen.

As the week progressed, growing perception that the U.S. Federal Reserve might increase interest rates sooner than later following recent healthy U.S. data, helped USD/JPY to move higher.

The yen was also pressured by fresh fund buying of foreign assets by Japanese investors at the start of the new business year. Data showed Japanese investors bought $1.67 billion in foreign equities in the week to April 2, backing up talk of fresh asset allocation overseas into the new fiscal year.

On the last trading day, the yen steadied against the dollar following early losses prompted by worries that the kidnapping of three Japanese civilians in Iraq could damage support for the government of Prime Minister Junichiro Koizumi.

A hitherto unknown Iraqi group, Saraya Al-Mujahideen (Mujahideen Brigades), released a video of the three hostages and vowed to 'burn them alive' if Japanese troops did not leave Iraq in three days.

However, Koizumi said that Tokyo had no intention of withdrawing its Self-defence Forces from the southern Iraqi city of Samawa, where some 550 troops are involved in a non-combat mission.

Range for the week: 104.00 - 108.00

Sterling

Sterling dropped 1 pct against the dollar at the beginning of the week, hurt by strong U.S. data, which bolstered expectations of a sooner-than-expected interest rate hike by the U.S. Federal Reserve.

Sharp fall in Britain's manufacturing also pressured the pound. Surprisingly, manufacturing production also fell 0.6 pct during February from 0.2 pct in January compared with market's forecast of 0.4 pct rise.

As expected, the Bank of England's Monetary Policy Committee left interest rates unchanged at 4 pct.

However, speculation that BoE may hike interest rates, possibly as soon as its meeting in May, limited the pound's downward trend. The UK central bank has raised interest rates twice since November last year.

Range for the week: $1.8100 - $1.8600