CURRENCIES: Dollar Rises Vs. Yen On Core PPI, Sterling Hits New 26-year Peak

The dollar rose against the yen Tuesday after U.S. government reports showed core inflation at the wholesale level rose more than forecast last month while monthly capital flows to the U.S. jumped in May.

The British pound rallied to a new 26-year peak against the dollar after a report showed U.K. inflation didn't cool as much as forecast last month, reinforcing expectations that the Bank of England will continuing hiking interest rates.

"The take away from today's deluge of U.S. data is that the recent decline in the dollar owes more to positioning than real money flows," said Michael Woolfolk, senior currency strategist at The Bank of New York. "However, players appear cautious of buying dollars ahead of [Fed Chairman Ben] Bernanke's congressional testimony tomorrow."

In New York trading, the euro stood at $1.3781, compared with $1.3772 late Monday. The euro hit a record high at $1.3813 last Friday. The dollar was quoted at 122.26 yen, compared with 121.86 yen.

The British pound was quoted at $2.0458, compared with $2.0369. Sterling had earlier risen to $2.0474, a fresh 26-year high. The dollar also changed hands at 1.2031 Swiss francs, compared with 1.2030 francs.

The euro was at 168.65 yen, compared with 167.81 yen.

The yen came under selling pressure, as a rally in U.S. stocks, which propelled the Dow Jones Industrial Average past the 14,000 level for the first time, encouraged carry trades. Carry trades refer to the practice of borrowing low-yielding currencies and reinvesting in higher-return currencies and assets.

U.S. data

Wholesale prices fell 0.2% in June as food and energy prices declined after four months of hefty increases, the Labor Department reported Tuesday. The producer price index fell for the first time since January, against economists' expectations for a 0.2% increase in prices for goods at the wholesale level.

Excluding volatile food and energy prices, the core PPI rose 0.3%, a tenth higher than the 0.2% gain expected. It's the biggest gain since February.

The dollar extended its gains against the yen after the Treasury Department said monthly capital flows to the U.S. rose to $105.9 billion in May, up from a revised $97.8 billion in April. Net foreign purchases of long-term U.S. securities, meanwhile, climbed to $163.5 billion from $97.4 billion.

Separately, the Federal Reserve said U.S. industrial production rose 0.5% in June, while capacity utilization rose to 81.7% from 81.4%. Economists were expecting production to rise 0.6% and capacity utilization to rise to 81.6%.

Bernanke, CPI awaited

The Labor Department will release the consumer price index for June on Wednesday morning. With gasoline prices falling during the month, economists surveyed by MarketWatch are looking for the CPI to show a very tame 0.1% increase. Excluding food and energy prices, the core CPI should increase a moderate 0.2% for June, they say.

Two days of congressional testimony by Fed chief Ben Bernanke will likely be the most significant event of a busy week for economic news, but analysts don't expect much change in the central bank's approach to growth, inflation and interest rates in his semiannual testimony for Wednesday and Thursday.

Bernanke will likely repeat the Fed's mantra that inflation risks are elevated, while growth can be expected to strengthen slightly, but remain semi-soft. The bottom line will likely be to cement expectations that the Fed won't change interest rates in either direction for quite a while.

Dollar sentiment

The dollar posted a loss of more than 1% against the euro and the yen last week after Wall Street's two largest rating agencies signaled that problems in the subprime market aren't going away and will probably get worse.

There's "continued uncertainty regarding the housing market," said Gareth Sylvester, currency strategist with HIFX.

"We're looking for a neutral policy from the Fed...and with the market focusing primarily on yields, the yield advantage continues to move away from the U.S. dollar" in favor of the pound, the Australian and New Zealand dollars, he said.

Bank of New York's Woolfolk said the market remains short dollars and is "likely to increase these positions if core CPI show further improvement tomorrow or Bernanke indicates price pressures are subsiding in line with the Fed's expectations."

U.K. inflation

U.K. consumer level inflation fell in June to 2.4% from 2.5% in May, the National Statistics Office said Tuesday, citing the impact from falling average gas and electricity bills. But that was higher than the 2.3% forecast by economists and the statistics office noted rising gasoline prices and sea fares.

The Bank of England targets inflation at 2%.

Core CPI, which excludes food, energy, tobacco and alcohol prices, rose to a 10-year high of 2%.

"With core CPI reaching its highest level in 10 years, the news will only serve to stiffen BoE's already hawkish posture as U.K. monetary officials make every effort to contain persistent price pressures in the system," said Boris Schlossberg, senior currency strategist at DailyFX.com.

"Unless U.K. consumption falls precipitously in the next few months, the BoE is very likely to push short term rates to 6% in order to diffuse further inflation expectations," he said, in a note to clients.

The euro showed little reaction after a report showed the German ZEW indicator of economic expectations fell to 10.4 in July, from a reading of 20.3 a month ago. Analysts had been forecasting a reading of around 19.5.

(END) Dow Jones Newswires