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The dollar started the fourth quarter in an upbeat fashion, breaching key resistance levels against both the euro and the yen as expectations of further US interest rate increases were cemented by an unexpectedly strong Institute of Supply Management manufacturing report.

The dollar had strengthened after a weaker-than-expected Tankan survey, and its momentum was reinforced by a major surprise from the September ISM manufacturing report. The market was prepared for a sharp fall following Katrina and Rita, but instead the headline ISM index surged to 59.4 from 53.6, the strongest reading since August 2004.

The dollar reached Y114.24 in Asian trade, its highest level for 16 months, before consolidating at around Y114.20. Dealers said the May 2004 price high at Y114.90 was the dollar’s next target.

Against the euro, the dollar breached the key resistance level of $1.20, reaching $1.1903, its lowest since early July, before retreating to $1.1910. Traders said the dollar could now test the $1.1870 level against the euro in spite of mounting hopes for an end to the political stalemate in Germany.

“The dollar will be well supported by the Fed’s interest rate stance,” said Stephen Jen of Morgan Stanley: “The US cash yield is so high, the dollar is now a full-fledged high-yield currency.”

In Japan, although the headline index for business conditions for large manufacturers was slightly below consensus expectations, analysts said the Tankan report was largely positive and consistent with real GDP growth of around 3 per cent in the second half of 2005. The euro traded at Y136.01, around 0.4 per cent weaker.

The dollar rose 0.8 per cent against the Swiss franc to SFr1.3039, close to its high for the year, before weakening slightly to SFr1.3024. Comments from Philipp Hildebrand, a board member at the Swiss National Bank, suggested growing concern about inflationary pressures. The market is currently pricing in a 60 per cent chance of a 25 basis points increase in December. The euro traded 0.3 per cent weaker against the Swiss franc at SFr1.5514 and some traders now expect a move towards SFR1.5400.

No change in Eurozone interest rates is expected from the European Central Bank on Thursday so the focus will be on whether the ECB’s language at the press conference has become more hawkish, reflecting the rise in inflation in September, the increase in broad monetary growth, and the continuing high level of oil prices.

No change is expected in UK rates from the Bank of England on Thursday, but the widening interest rate spread with the US is seen as negative for sterling as there have been few periods over the past decade when the UK and US differentials across the curve have been as dollar-positive as they currently are.

“With the evidence pointing to the likelihood that interest rate differentials will shift even further in the greenback’s favour in the months ahead, its seems to us that the stage is being set for a sharp decline in sterling against the dollar in the run-up to the end of the year,” said Simon Derrick at the Bank of New York.

Sterling slipped 0.6 per cent to $1.7545, attracting new selling in European trade after breaking below support at 1.758.

The Turkish lira was volatile in trading against the euro and the dollar amid fears that negotiations with the EU could be delayed as Austria is insisting on an alternative to full membership.

Against the euro, the lira weakened to TL1.6382 before recovering to trade at TL1.5950, around 1.6 per cent stronger. Against the dollar, the lira fell to TL1.3710 before recovering to $1.3405.

Traders said that a significant sell-off was unlikely unless Turkey pulled out of the negotiations.

Copyright The Financial Times Limited 2017. All rights reserved.
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