FOREX-Dollar gains vs yen on inflation, rate outlook

(Updates prices, adds comments, changes byline, dateline, previous LONDON)

By Steven C. Johnson

NEW YORK, May 22 - The dollar gained against the yen on Monday as the prospect of higher U.S. interest rates to ward off inflation prompted investors to shed exposure to high-risk assets in favor of the U.S. currency.

Strategists said the boost for the U.S. currency was tied to growing concern that the Federal Reserve will push interest rates higher next month to weigh against inflation.

That, coupled with comments by the Bank of Japan last week that it was in no rush to end its zero interest-rate policy, helped the dollar reverse a month-long decline against its main rivals that had sent it to an eight-month low against the yen and a one-year trough versus the euro last week.

At one point in the European session, the dollar advanced more than 1 percent against the yen, hitting a two-week high of 112.93 yen before easing back as New York trade got under way.

"People are really starting to rethink the interest rate outlook," said Meg Browne, currency strategist at Brown Brothers Harriman in New York.

As investors lighten exposure to risky assets such as commodities, emerging market debt and equities, it will make for "a more volatile foreign exchange market, with choppier trading and bigger (price) swings," Browne said.

Around 9:40 a.m. EDT (1440 GMT), the dollar was up 0.62 percent on the day at 112.37 yen <JPY=>. Traders said dollar selling would be triggered around 113 yen, said to be an options barrier.

The euro <EUR=> had reversed earlier losses and was a touch higher at $1.2785.

The Australian dollar, which often moves in tandem with commodities prices, was the biggest loser against the greenback, off 1.3 percent on the day at $0.7485 <AUD=>.

CHANGING EURO VIEWS

The euro, after weakening slightly versus the dollar during European trade, was buoyed by remarks from European Central Bank President Jean-Claude Trichet, who reiterated that the ECB remains vigilant on inflation.

Like the Fed, both the ECB and Bank of Japan will hold policy meetings in June, with the ECB seen likely to boost rates.

Also helping shield the euro from the dollar's broader upside were comments from the Greek and Dutch finance ministers who said they were not worried about the currency's recent strength, which culminated in a one-year high of $1.30 last week.

But it was the Fed and the outlook for U.S. rates that took center stage for currency investors.

International Monetary Fund chief Rodrigo Rato said on Monday that strong U.S. data could force the Fed to continue lifting rates, and warned that the ECB and BOJ should tread more carefully.

"There is greater uncertainty now on interest rates than there has been for some time, and that's translating into the dollar's stability for the time being," said John McCarthy, director of foreign exchange at ING Capital Markets in New York.

As such, traders will pay close attention to a speech by Dallas Federal Reserve President Richard Fisher at 1:00 p.m. EDT (1700 GMT). (Additional reporting by Veronica Brown in London)