The dollar pushed to a new 25-month high against the yen and breached the $1.20 level against the euro on Monday. The US currency was boosted by the strong gains in world equity markets.

“On a day when equity markets are strong, clearly the confidence in the US economy is there and that supports the dollar,” Simon Hayley of Capital Economics said.

The greenback was also buoyed ahead of decisions this week on interest rates by the European Central Bank and the US Federal Reserve which are seen increasing the US currency’s yield differential. The ECB is expected to hold interest rates while the Fed is expected to increase them.

Data on Monday showed that the Fed’s favoured gauge of inflationary pressure, the core personal consumption expenditure index, rose 2 per cent year-on-year in September, the upper limit of the central bank’s comfort zone. The monthly PCE rate was higher than expected at 0.2 per cent. Economists on average had been forecasting 0.1 per cent.

Also encouraging on the economic front was the Chicago purchasing managers gauge of business activity for October, which was stronger than expected.

Economists are expecting the Fed will raise rates by a quarter of a percentage point today, but the future path of eurozone rates is less clear.

“We expect the FOMC to raise another 25bps to bring Fed funds up to 4.00 per cent and again next month to 4.25 per cent,” Mansoor Mohi-uddin of UBS said.

Not one of 42 economists polled by Bloomberg expect the ECB to raise rates on Thursday, but according to UBS the market is pricing in a 60 per cent chance of an ECB rate rise in December.

Mr Mohi-uddin said said the combination of better sentiment indicators last week, hawkish ECB commentary and strong broad money supply numbers had prompted UBS to bring forward its forecast for ECB tightening. It was now projecting a 25bps rate hike in December and another hike late in the first-quarter of 2006.

Further support for the dollar against the euro was evident in data from UBS showing a net $0.48bn of capital flowed into the US supporting the dollar last week, “once again due predominantly to US customer repatriation”, while foreign investor selling led to a net $0.90bn outflow from the eurozone.

Hans Redeker of BNP Paribas suggested the resignation of Franz Müntefering, chairman of Germany’s SPD, could weigh on the euro by delaying the confirmation of the proposed coalition government.

The euro fell 0.9 per cent to $1.1991 against the euro, and 0.3 per cent to Y139.55 versus the yen.

The Japanese currency saw little benefit from bolstered expectations the Bank of Japan could end its “quantitative easing” policy, possibly in the first half of 2006. The BOJ outlined how it would phase out the policy by reducing the current account target, and then targeting interest rates.

The possibility of a policy change would increase next

year, the BOJ said, and assured interest rates would remain extremely low even after it ends its “quantitative easing” policy.

It also forecast core consumer price index for fiscal 2006/07 as 0.5 per cent - up from its previous estimate of plus 0.3 per cent.

The median projection for the current fiscal year rose to 0.1 per cent from minus 0.1 per cent.

The BOJ has said “quantitative easing”, the policy of near zero interest rates combined with flooding the banking system with cash, will not end until core CPI rises above year-ago levels on a sustained basis.

The yen lost 0.6 per cent on the dollar to Y116.35 and the pound lost 0.5 per cent to $1.7686 versus the greenback.

Sterling strengthened against the euro, up 0.5 per cent to £0.6779 on news Telefónica of Spain had bid nearly £18bn for mobile phone company O2. But “any FX impact is likely to be muddied by the fact that Telefónica has secured a loan for the entire amount”, Mr Marta cautioned.

“It’s (still) a very very chunky sterling positive,” Paul Mackel of ABN Amro said.

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