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Dollar Rises as Fed Minutes Add to Expectations for Higher Interest Rates

Feb. 21 (Bloomberg) -- The dollar rose for a second day versus the yen as the minutes of the Federal Reserve last meeting added to expectations for further interest-rate increases.

Fed policy makers, in former Chairman Alan Greenspan’s last interest-rate meeting on Jan. 31, said more rate increases may be needed because inflation has been ‘somewhat higher’ than acceptable, minutes of the session showed. “It supports the interest rate differential story that we are going to have higher short term rates,” said Adnan Akant, head of foreign exchange in New York at money manager Fischer Francis Trees & Watts, with USD 37 billion in assets. “The dollar has been grinding higher.”

The dollar climbed to 118.68 JPY/USD at 2:53 p.m. in New York from 118.26 JPY/USD late yesterday. The U.S. currency has risen about 1 percent this year versus the yen. Against the euro, the USD pared its gain to 1.1925 USD/EUR from 1.1936 USD/EUR. Markets in the U.S. were closed yesterday for the Presidents” Day holiday.

The USD rallied against the JPY last week after newly appointed Fed Chairman Ben S. Bernanke said a sustained U.S. expansion may require the central bank to add to its 14 straight rate increases since June 2004. Higher rates may help the USD extend its 14 percent gain versus the EUR and JPY last year.

“In the view of some members, the possibility of additional policy moves was reinforced by readings on core inflation and inflation expectations that were somewhat higher than was desirable over the long run,” the Federal Open Market Committee said in documents released today in Washington.

Traders are pricing in a 98 percent chance the Fed will raise its interest-rate target a quarter-percentage point to 4.75 percent in March and about a 70 percent chance of an increase to 5 percent in May, interest-rate futures indicate.

Few Surprises

Some of the language of the minutes suggest that the Fed is going to be more data dependent and that they are concerned about inflation and see strong growth ahead. “A hike in March and May cannot be seen as a foregone conclusion if you read the meeting minutes word for word,” said Michael Woolfolk, senior currency strategist with Bank of New York. “It’s going to hinge on data that is yet to be released.”

The dollar declined the most against the euro in three months after the Fed released minutes of its Dec. 13 meeting on Jan. 3. The central bank tempered expectations of future interest rate increases by saying they “probably would not be large.” “If you look at year to date, the dollar is flat,” said Fischer of Francis Trees. “We don’t see too much dollar strength going forward.”

‘Favors the Dollar’

A report today showed an index of U.S. leading indicators rose for a fourth straight month as the labor market improved and manufacturing strengthened, pointing to faster economic growth. The Conference Board’s index for January rose 1.1 percent, the biggest gain since June, after December’s revised 0.3 percent increase. The last time the index rose for more than three months in a row was in 2004.

The consumer price index probably rose 0.5 percent in January, the most in four months, according to a survey before a Labor Department report tomorrow.

Treasuries due in two years yield 1.77 percentage points more than similar maturity German bonds, near the widest difference since Dec. 5, and more than the five-year average of 38 basis points. The premium Treasuries due in 2008 give investors over comparable Japanese bonds is 4.28 percentage points. A basis point is 0.01 percentage point.

Euro Expectations

European Central Bank council member Nicholas Garganas suggested the ECB will raise its growth and inflation forecast, raising expectations the central bank will lift borrowing costs at its policy meeting on March 2.

“Euro-area growth will pick up at a faster pace,” said Garganas, also head of the Bank of Greece, in an interview in Athens late yesterday. “Inflation risks have increased since the last forecast.” ECB President Jean-Claude Trichet reiterated yesterday that “vigilance” is needed to stem quickening inflation in the euro region when he spoke at the European Parliament and repeated that market expectations for ECB rate increases are “reasonable.”

Traders expect the ECB to lift its benchmark rate by a quarter point next month to 2.5 percent, after it raised rates for the first time in five years in December, interest-rate futures indicate.

The yield on the three-month Euribor contract due March 2006 was 2.68 percent today. The contracts settle to the three-month interbank offered rate for the euro, which has averaged 15 basis points more than the ECB’s key rate since the currency’s launch in 1999.

Chinese Yuan

The dollar extended gains after China’s central bank pledged today to keep the yuan at a “reasonable, balanced” level. The People’s Bank of China also said in its quarterly monetary policy report that it was committed to improving its exchange-rate system.

China revalued its currency by 2.1 percent on July 21 and allows it to trade 0.3 percent either side of the previous day’s close under pressure from the U.S. and the European Union, who say that an undervalued yuan gives Chinese exporters an unfair advantage.

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