NEWS / Central Banks

Dollar clings to gains in nervous trade

By Katie Hunt

LONDON - The dollar held near a two-month high against the yen in choppy trade on Friday ahead of an expected bump up in U.S. interest rates next week and on caution over the fate of Bank of Japan Governor Toshihiko Fukui.

With no significant economic data due leading up to the Federal Reserve's rate decision on Thursday, trading was prone to speculative deals and an overreaction to rumours.

The yen hit session highs on market talk that China would announce new currency measures but reversed when the People's Bank of China said a statement would not be related to the yuan

but instead focus on a review of global finance.

"It's a Friday and the market is a bit nervous. People think these levels in dollar/yen look good to go short. The talk of a PBOC statement is a good excuse," said a trader at a UK bank.

By 0730 GMT, the dollar was at 116.01 yen after falling as low as 115.77 yen on the yuan rumour. The dollar shot up over 1 percent on Thursday to a two-month high of 116.29 yen.

The euro traded at 145.99 yen after falling to 145.72 yen on the China talk. The euro cleared a lifetime high against the yen of 146.28 yen on Thursday.

Against the dollar, the single European currency was little changed from the U.S. close at $1.2576.

YEN OUTLOOK CLOUDY

The yen's outlook remains clouded due to a controversy over Fukui's investment years ago in an equity fund run by a financier indicted on Friday on suspicion of insider trading.

Although Prime Minister Junichiro Koizumi and ministers have strongly backed the BOJ chief, the yen has come under pressure this week from persistent speculation that Fukui may resign.

Fukui was grilled by lawmakers again on Friday and reiterated that he wanted to stay in his post.

"I think the government side wants to quickly put an end to this issue, but it looks like it could drag on," said Daisuke Uno, market strategist at Sumitomo Mitsui Banking Corp in Tokyo.

Key to yen weakness are concerns the fuss over Fukui could affect the timing of an interest rate hike, though comments by BOJ officials have dovetailed with market forecasts for the central bank to boost rates from near zero as early as July.

"Even if he were to step down, the BOJ would probably stay on track to normalise monetary policy, so it shouldn't have a long-term impact on the market," said Tohru Sasaki, chief forex strategist at JPMorgan Chase Bank in Tokyo.

FED FOCUS

The dollar was buoyed on Thursday by rumours that Fed officials, possibly including Chairman Ben Bernanke, had met with bond market participants on Wednesday.

That fanned speculation the Fed might raise rates by half a percentage point, although most traders were sceptical and stuck to forecasts for a quarter point rise to 5.25 percent.

Expectations that the Fed will keep raising rates should continue to support the dollar beyond next week.

"Judging from comments from Fed officials in the past month or so, there probably won't be any comments in the post-FOMC statement suggesting the Fed will stop raising interest rates," said a dealer at a Japanese bank.

U.S. durable goods orders for May are the only major data on Friday. Due at 1230 GMT, orders are expected to rise 0.5 percent compared with a 4.4 percent drop in April.