Bank of England set to raise rates

Euro

At the start of the week the dollar retreated as investors took profits from last week's gains and awaited a string of U.S. data to see whether the numbers would support the Federal Reserve's optimism on the U.S. economy.

The greenback rallied last week as upbeat comments by Federal Reserve Chairman Alan Greenspan on the world's largest economy fuelled views that the central bank could raise interest rates at a faster pace. The markets have viewed measured monetary tightening by the Fed as dollar-negative. Higher rates generally would boost the allure of the dollar denominated investment returns.

Midweek however, the dollar vaulted to a five week high against the euro after strong data added fuel to a rally sparked by Greenspan's comments. A better-than-expected consumer confidence report for July further boosted the dollar, already well bid after Greenspan signalled tightening monetary policy more quickly posed less of a risk to U.S. economic recovery than leaving official rates too low for too long.

The Conference Board consumer confidence index for July rose to 106.1 from a revised 102.8 in June for the fourth straight monthly rise in the private forecaster's index. Economists had forecast a reading of 102.0.

Meanwhile, the European Central Bank policy makers said the ECB is not expecting to raise interest rates in the next few months and while the German economy is improving, it still lacks a solid footing.

The greenback however was forced to shed some of its gains after a surprisingly robust German business survey and on news that a United Airlines flight from Sydney to Los Angeles had to turn back after a note raising fears of bomb threat was found on board. The Ifo Institute said its German business climate indicator rose to 95.6 from 94.6, beating the consensus in a Reuters poll of economists for an increase to 95.0.

The final trading session of the week witnessed the greenback gain substantial ground against the euro testing a six-week peak of $1.1990 per euro. , as markets viewed the latest batch of economic data as positive for the currency.

The Chicago purchasing management index, which gives a view of U.S. Midwest business activity, bounced to 64.7 in July from 56.4 in June, giving the dollar much-needed ammunition to move higher. Earlier in the session, the dollar fell after news that U.S. second-quarter gross domestic product expanded at a 3.0 percent pace after an upwardly revised 4.5 percent clip at the start of the year.

Expectations were for a growth of 3.6 percent. The U.S. currency also benefited from news that Pakistan had arrested a senior al Qaeda figure wanted for the 1998 bombings of two U.S. embassies in Africa that killed hundreds of people.

In the coming week, the U.S. labour market will take centre stage as markets keenly await the August 6 non-farm payrolls report to confirm or confound expectations the Federal Reserve will gradually keep moving interest rates higher.

Economists predict July's report will show the U.S. economy created 220,000 new jobs. This would compare favourably to the modest gains of 112,000 payrolls recorded in June. Meanwhile, the European Central Bank which meets on Thursday is expected to leave interest rates unchanged at the historically low level of 2.0 percent.

Range for the week: $1.1850 - $1.2150

Japanese Yen

The dollar gained versus the yen having vaulted to a two-month high of 112.48 yen as investors cheered an upbeat assessment of the U.S. economy and bet for gradual increases in U.S. interest rates after the Fed Chairman Alan Greenspan said recent economic softness was transitory. But the dollar failed to maintain its footing as the Japanese currency shrugged off another surge in oil prices to record highs.

Japan is heavily dependent on oil imports and the yen tends to suffer when oil prices rise. The yen however rebounded by one yen and closed at 111.40, gaining modest support from a 1.88 percent bounce in the Nikkei and on data showing core Japanese inflation fell less than expected in June.

Range for the week: 110.00-113.00

Sterling

Sterling steadied near recent one-month lows against the dollar as investors priced in a widely expected UK rate hike next week.

Forty-four of 45 economists polled by Reuters this week expect the Bank of England to raise interest rates by 25 basis points to 4.75 percent following its monthly policy meeting on Wednesday and Thursday.

However, sterling has been under pressure as the outlook for the U.K economy and future rate hikes had become more uncertain after recent mixed data. Sterling has lost seven cents against the dollar from five-month highs set a week ago, partly due to a broad recovery in the U.S. currency.

Sterling has benefited as the BoE has raised rates in quarter point steps in November, most recently in May and June, partly to cool rampant house price inflation and curtail consumer debt. But the economic outlook is looking less clear as consumer credit data released during the week raised concern that high house prices, frequently remarked on by BoE officials, could prove unsustainable.

Range for the week: $1.8000- $1.8300