Euro to Benefit on Expectations of Rising Rates

Expectations interest-rate differentials will widen further in Europe's favor should buoy the euro against the dollar this week, while investors will closely watch U.S. inflation data that could help shape Federal Reserve monetary policy.

The euro rose to a 15-month peak versus the dollar Friday, on pace for a gain of 1.7 percent this week. The prospect of a U.S. government shutdown, which would idle about 800,000 federal government workers and put a crimp in the economic recovery, weighed on the dollar.

The European Central Bank raised rates by 25 basis points Thursday, its first hike since the 2008 financial crisis, and signaled it's ready to tighten further if needed. Expectations of higher rates boosted the euro even as Portugal became the third euro zone country to request a bailout.

"The market is ignoring all of Europe's fiscal and banking troubles and trading off a single indicator -- interest differentials," said Avery Shenfeld, chief economist at CIBC World Markets in Toronto.

The euro was last up 1.1 percent at $1.4459, climbing to a session high of $1.4465 on Reuters data after taking out reported option barriers at $1.4450. The level also marks the 61.8 percent retracement of the move from the euro's record high above $1.6000 hit in 2008 to the 2010 low of $1.1876.

Traders cited further upside targets of $1.4500 and the January 2010 high around $1.4580.

"At this point, the euro has been on a one-way ticket north and pretty easily could break $1.45 next week," said John Doyle, strategist at Tempus Consulting in Washington.

U.S. INFLATION

The dollar was pressured as the White House and Congress worked frantically to break a U.S. budget deadlock by the end of the day in order to avoid a government shutdown.

A shutdown would be far-reaching, since among other actions it would stop payment of government suppliers and possibly close private enterprises reliant on government operations.

The lost wages and spending would ripple through to other areas of the economy at a time of uncertain economic growth, though some analysts noted that any impact would be short-lived and government spending for the year would be the same.

Investors will watch March U.S. retail sales data next week to gauge the strength of consumer spending. A round of inflation readings, including consumer and producer prices, will also be scrutinized and a pick-up in inflationary pressures could see investors bring forward expectations of U.S. rate hikes, which would lift the dollar.

Against the yen, the dollar slipped 0.1 percent to 84.76 , still within striking distance of a six-month high hit this week. Market players said the yen could weaken further on expectations the Bank of Japan will keep monetary policy stimulative for much longer following the country's massive earthquake and nuclear crisis.

Speculators cut bets in favor of the yen this week, going short the Japanese currency by the biggest margin in nearly a year, data showed Friday, and built up a record long position in the Australian dollar.

The data, released by the Commodity and Futures Trading Commission, also showed net short U.S. dollar position fell slightly to $25.18 billion in the week to April 5.

The Australian dollar rose to $1.0552, its highest level versus the greenback since it was floated in December 1983. The aussie has benefited from strong domestic economic growth, staving off the malaise of the rest of the developed world in recent years, fueled in large part by exports of raw materials to China.