Dollar index hits 11-year high as US/euro zone rate gap widens

[March 03, 2015]  By Anirban Nag

LONDON (Reuters) - The dollar rose to 11-year high against a basket of major currencies on Tuesday, with the U.S. currency hitting a six-week high against the euro as interest rate differentials moved in favor of U.S. Treasuries.

The yield gap between two-year U.S. Treasuries and euro zone government bonds <EU2YT=RR> widened ahead of details of the European Central Bank's 1.1 trillion euro bond buying program, giving the dollar a boost, traders said.

The euro fell 0.25 percent against the dollar to $1.11545 pushing the dollar index to 95.57, its highest level since Sept. 2003.

While U.S. yields inched up, most euro zone bond yields held near record lows as investors waited for the ECB to provide more details of its trillion euro quantitative easing (QE) program later this week.

"We have always placed great weight on QE as a driver of FX and finally the ECB will start it," said Jonathan Webb, head of FX strategy at Jefferies. "While it is clear that the euro move lower already pre-empted the implementation of QE, we expect the actual flows will continue to weigh on the currency."

It was not all-round gains for the dollar, though. The dollar fell against the yen after an economic adviser to Japanese Prime Minister Shinzo Abe said the U.S. currency could not sustain more gains.

Etsuro Honda, who some analysts described as a proponent of yen weakness, told the Wall Street Journal in an interview that dollar/yen may be at a "kind of upper limit in the exchange rate's comfort zone".

The comments pulled the dollar off a three-week high of 120.27 yen hit earlier due to a spike in U.S. debt yields. It last traded at 119.80, down 0.3 percent.

"Honda's comments reflect the latest view of the government and come ahead of a proposed visit by Abe to the United States in April," said Yujiro Goto, currency strategist at Nomura.

"They might not want the yen to weaken too much ahead of the visit. So in the short term the yen's weakness could slow, but over the medium term it will still weaken."

Some countries, especially in the G7, had complained about sharp yen weakness in early 2013, just as Abe came to power and the Bank of Japan was about to embark on a huge quantitative easing program to get inflation back to 2 percent.

The criticism about waging a "currency war" by driving the yen sharply lower to boost exports has made the Japanese sensitive to excessive weakness in the currency.

Nevertheless, with the Federal Reserve expected to tighten monetary policy sometime later this year, the dollar is likely to resume its upward trek, traders said.

The Australian dollar rose 1 percent against the greenback after the Reserve Bank of Australia opted to leave its policy rate unchanged at a record low of 2.25 percent. The Aussie jumped to a high of $0.7845 before easing back to $0.7805, still up 0.5 percent on the day.

(Editing by Jon Boyle)

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