Dollar rises to 7-month high vs yen

By Vivianne Rodrigues

NEW YORK (Reuters) - The dollar hit a seven-month high against the yen on Wednesday as a drop in oil prices and renewed expectations of low Federal Reserve interest rates were seen as helping the sluggish U.S. economy.

Demand for the euro fell ahead of the European Central Bank policy meeting on Thursday. The bank is widely expected to leave benchmark borrowing costs unchanged at 4.25 percent.

The Fed on Tuesday also held its benchmark federal funds rate steady at 2 percent and signaled in a statement that it is in no rush to raise borrowing costs higher.

"The U.S. economy is showing some signs of recovery and oil prices falling does help," said Meg Browne, a currency strategist at Brown Brothers Harriman in New York. "Going into the end of the year and into 2009, the tip will be moving in favor to the U.S. dollar."

In midday trading in New York, the dollar traded 1 percent higher at 109.38 yen, the highest since January, according to Reuters data. The dollar was on track for its highest daily gain against the Japanese currency in three weeks.

The dollar's surge "reflects improved risk appetite and fading odds of a Fed tightening," said Ashraf Laidi, chief strategist at CMC Markets US.

The yen also fell against the euro, as gains in European shares whetted investors' appetite for riskier assets, diminishing the Japanese currency's safe-haven allure.

The dollar index .DXY, which tracks the U.S. currency's movements against the currencies of major trading partners, was 0.4 percent higher at 74.223, recovering from an earlier slip.

With the Fed meeting over, investors turned their attention to the ECB's policy views.

"Now the market's attention is shifting to the ECB meeting tomorrow and (ECB President Claude) Trichet is likely to make some pretty hawkish remarks," Browne said. "But he will also have to acknowledge that economic growth in Europe has been pretty slow."

While the rate differentials between the United States and Europe still favor the euro in the short term, Browne said slowing growth in the euro zone will eventually lead the ECB to cut borrowing costs despite worries about inflation.

The euro eased against the dollar and last traded down 0.3 percent at $1.5405, retreating from earlier gains.

A Reuters poll of 61 strategists taken August 4-6 showed most expect the euro to trade at around $1.54 over the next three months, before retreating to $1.50 in six months and $1.44 a year from now.

U.S. crude prices seesawed on Wednesday and last traded 0.8 percent lower at $118.23 a barrel.

With crude oil prices down almost $30 from a record above $147 a barrel in mid-July, and forecasts of zero growth in the euro zone economy in the second quarter, the euro's peak may well have been reached, the poll showed.

Demand for the euro also fell as a report showed German manufacturing orders for June dropped by a sharp 2.9 percent and stoked fears of a sustained period of weakness in Europe's biggest economy.

"European data has been surprising strongly to the downside," currency strategists at UBS AG said in a note. The bank also said that following Tuesday's FOMC statement which was "fractionally less dovish" than expected, it's hard to imagine that the ECB will turn dovish at this point in time.

Any ECB-induced bounce in the euro should offer good selling opportunities, UBS added, given expectations for more weak European data and inflation peaking this quarter.

(Additional reporting by Lucia Mutikani in New York; editing by Gary Crosse)