Dollar's Rally Stalls; Traders Seek Signs of Economic Strength

March 22 (Bloomberg) -- The dollar's two-day rally against the yen and euro stalled as traders said they need more evidence the Federal Reserve will raise interest rates twice more before pushing the U.S. currency higher. The dollar gained to start the week, following its biggest weekly loss in two months, as investors rebuilt expectations U.S. rates will rise more than in Europe and Japan. Traders must wait for tomorrow's reports on jobless claims and home sales for more evidence the U.S. economy is accelerating. "The dollar's upside momentum has slowed,'' said Marc Chandler, the global head of currency strategy at Brown Brothers Harriman & Co. in New York. The dollar fell to 116.74 yen at 8:36 a.m. in New York from 117.27 yesterday. It traded at $1.2090 per euro from $1.2095 late yesterday. The U.S. currency will rally to at least $1.15 by the third quarter, Brown Brothers forecasts. The U.S. currency initially declined today after Fed Chairman Ben S. Bernanke said in a letter yesterday to Representative Brad Sherman "the possibility of a future disruptive correction of the U.S. trade deficit cannot be ruled out.'' A widening U.S. trade deficit sent the dollar lower against the euro and yen from 2002 to 2004. Traders expect the Fed to raise rates at least twice more this year after 14 straight increases since mid-2004 to 4.5 percent. U.S. jobless claims probably remained above 300,000 for a third straight week, while sales of existing homes likely slowed about 0.9 percent to a 6.5 million annual rate, according to the median forecasts in surveys by Bloomberg News.

Bank of Japan Governor Toshihiko Fukui said today the bank hasn't decided when to lift rates from zero percent, where they've stood since 2001. The European Central Bank on March 2 raised its benchmark for the second time in three months to 2.5 percent. "The Fed continues to underpin the view that more rate hikes are highly probable, and yield premiums favor the dollar in the short term,'' said Jeremy Stretch, a currency strategist at Rabobank Groep in London. Fukui told a parliamentary committee in Tokyo that the central bank has no "predetermined time frame'' for lifting rates. Japan's central bank on March 9 voted to reduce the amount of money it makes available to lenders, ending a policy of flooding the world's second-largest economy with money to combat deflation.

The euro earlier fell against the dollar and the yen after a report showed industrial orders in the 12 nations sharing the common currency fell more than expected in January. Orders dropped 5.9 percent from the previous month, the biggest decline since May 1997, a European Union report showed. Economists surveyed by Bloomberg had expected a 0.2 percent decline. The prospect of higher rates has sent the euro up 1.9 percent versus the dollar this year. "It was a bad number and traders don't have anything else important to trade off today,'' said Armin Mekelburg, a currency strategist at HVB Group in Munich. "There has been some exaggerated optimism on how high ECB rates would go.'' The dollar has rebounded from its biggest weekly loss in two months as traders renewed bets on how high the Fed is likely to push rates. Interest-rate futures show traders have fully priced in a rate increase to 4.75 percent at the Fed's meeting March 28. The chance of another increase to 5 percent in May rose to about 90 percent from 73 percent March 17.

"We're back to 5 percent expectations and the dollar is recovering from its sharp slide of last week,'' said John Kyriakopoulos, a currency strategist at National Australia Bank Ltd. in Sydney. "The dollar has a little further to go.'' The U.S. currency yesterday had the biggest gain in two weeks versus the euro and the yen after a key gauge of inflation rose more than expected. Prices paid to factories and other producers last month, excluding energy and food, rose 0.3 percent, compared with the 0.1 percent forecast in a Bloomberg economist survey. Gains for the dollar versus the euro may be limited after ECB policy maker Axel Weber said today he's concerned about inflation in the euro-region. The Frankfurt-based central bank's March 2 forecast for inflation to hold above 2 percent this year and next is "a certain cause for concern,'' he said in an interview in Frankfurt yesterday. Investors expect the ECB to raise its rate to as high as 3.25 percent by the year-end, futures trading shows.