Dollar clings to gains as US rate outlook diverges from peers

FILE PHOTO: A picture illustration shows U.S. 100 dollar bank notes taken in Tokyo August 2, 2011. REUTERS/Yuriko Nakao/File Photo

By Laura Matthews

NEW YORK (Reuters) - The dollar rose against other major currencies on Friday, hitting a fresh eight-week high against the yen as data showed a strong U.S. economy and as the Federal Reserve's patient approach to interest-rate cuts contrasts it with more dovish peers.

U.S. business activity inched up to a 26-month high in June amid a rebound in employment while price pressures subsided considerably, suggesting that a recent slowdown in inflation was likely to be sustained.

The dollar index, which measures the currency against six others, was last up 0.2% at 105.82. It had spiked 0.41% overnight, erasing declines for the week, following a second successive rate cut at the Swiss National Bank and hints from the Bank of England of a reduction in August.

"Coming on the back of disappointing (purchasing managers' index) figures out of Europe, the stronger-than-expected U.S. PMIs have revived the 'U.S. economic exceptionalism' narrative and may well close the door on any potential for a July rate cut from the Fed," said Matt Weller, head of market research at StoneX, Grand Rapids, Michigan.

Weller said the yen will be a key flashpoint for FX traders to watch into next week.

The U.S. Treasury on Thursday added Japan to a list of countries it is monitoring for potential labelling as a currency manipulator. China is among others on the list.

The period covered by the Treasury's report spans the four quarters to December 2023 and does not include April and May this year, when the report said Japanese authorities intervened to prop up the yen.

"USD/JPY closed at a 34-year high yesterday, within an hour of the U.S. Treasury putting Japan on its currency-monitoring list," said Weller. "This serves as a diplomatic warning against additional intervention from the BOJ and (Ministry of Finance) and, combined with today's better-than-expected U.S. data, could drive USD/JPY back toward 160.00 next."

The yen has been under pressure after the Bank of Japan's decision last week to hold off on reducing bond-buying stimulus until its July meeting. The dollar last traded 0.3% stronger at 159.37 yen.

The BOJ, at the behest of Japan's finance ministry, spent some 9.8 trillion yen ($61.64 billion) to haul the currency back from a 34-year trough of 160.245 per dollar, reached on April 29.

Japan's top currency diplomat Masato Kanda said on Friday that Tokyo stands ready to take further "resolute" action against "speculative, excessive volatility".

The dollar held its near five-week high against Sterling, which remains down 0.14% at $1.2639, its lowest since around mid-May. The BoE kept rates on hold this week, but some policymakers said the decision not to cut was "finely balanced".

Data on Friday showed UK retail sales rose by more than expected in May, in large part because of milder weather.

A separate report showed British business growth slowed to a seven-month low in June, weighed down by nerves about the July 4 general election.

The euro eased 0.1% to $1.0694 after a series of preliminary surveys for June showed service-sector activity in France contracted this month, while activity across the German economy slowed.

"We have had some slightly weaker PMIs out of Europe and the U.K., but election noise in France and the U.K. is likely distorting these figures and has muted the market reaction to these figures," said Erik Nelson, macro strategist at Wells Fargo in London.

(This story has been refiled to correct a typo, to read "against the yen" instead of "above", in paragraph 1)

(Reporting by Laura Matthews in New York; additional reporting by Kevin Buckland in Tokyo and Amanda Cooper in London; Editing by Jacqueline Wong, Christina Fincher, Barbara Lewis, Jane Merriman and Rod Nickel)