Dollar falls against euro on ECB rate expectations; yen slips

NEW YORK (AFP) - The dollar traded mainly lower yesterday as the euro gained ground on heightened expectations of an interest rate hike next month by the European Central Bank.

But the greenback firmed against the yen, which came under selling pressure after the Bank of Japan held its key benchmark lending rate at 0.50 percent following a two-day policy meeting.

The euro rose to 1.3566 dollars around 2100 GMT, up from 1.3541 dollars in New York late on Wednesday. The single European currency had risen as high as 1.3588 dollars in earlier trading, marking its highest level against the dollar since August 14.

The dollar picked up traction against the Japanese yen, however, as it rose to 116.28 yen, compared with 115.31 yen late Wednesday.

"The market's current view of (potential) US rate cuts, and now a boost to an (expected) ECB September hike, offers euro/dollar some underpinning," said Commerzbank analyst Gavin Friend.

The European Central Bank appears set to hike eurozone-wide interest rates next month by a quarter-point to 4.25 percent, analysts said.

In a statement on Wednesday, the ECB confirmed that its monetary policy stance had not changed from earlier in the month.

ECB chief Jean-Claude Trichet's use of the code words "strong vigilance" on August 2 was widely seen as a hint that rates would rise.

Investors favor currencies in countries with higher interest rates, such as the euro or the British pound, because they offer a higher rate of return than currencies from countries with low interest rates, such as the yen.

Although the euro gained on an expected rate hike, the dollar also declined as doubts emerged about whether the credit crunch afflicting US and global stock markets is easing or in fact continuing.

A move by the Federal Reserve to pump 17.25 billion dollars into the stressed US financial system in three injections yesterday caused some jitters as analysts vied to gauge the depth of the credit turbulence buffeting the banking sector.

The Fed has injected tens of billions of dollars into the banking system in the past week in a bid to boost credit flows and stop the banking system from clogging up.

Increased expectations that the Fed will move to trim US borrowing costs on September 18 at a scheduled interest rate meeting also undercut the dollar, analysts said.

The Fed's key Fed funds short term interest rate has been anchored at 5.25 percent since June 2006.

"The equity rally made the Japanese yen the biggest loser on the day, declining against all of the world's major world currencies," said David Rodriguez, a market analyst at Forex Capital Markets.

US stock markets finished the day on a lackluster note amid lingering fears about a liquidity squeeze, but gains were seen elsewhere, particularly across Asia.