LONDON: The dollar rose to a six-month high against a basket of currencies, buoyed by sharp gains against the euro on growing evidence the US economy is picking up even as the euro zone struggles.
Traders said poor economic data in the euro zone, along with cooling inflation and growing risks that political instability in Italy would push up borrowing costs for struggling European countries, could combine to exert pressure on the European Central Bank (ECB) to lower interest rates in coming months. That is likely to keep the euro weak.
Investors were also focused on $85 billion in US budget cuts that are due to start on Friday, although concerns about the impact on the world's largest economy could merely encourage buying of the highly liquid dollar as a safe haven.
Interest rate spreads between two-year US government bonds over their German counterparts were moving in favour of the former, offering another reason to investors to buy the dollar. More and more investors are expecting the Federal Reserve to slow its asset purchase programme later in the year as the US labour market shows signs of improvement.
Data on Thursday showed a drop in new claims for jobless benefits in the US last week and a sharp rise in factory activity in the Midwest. In contrast, joblessness in the euro zone rose to a all-time high while business surveys showed manufacturing activity was sluggish in February.
The dollar index rose 0.5 percent to 82.357, its highest level since late August. It gained as the euro fell to its 2013 low of $1.29855, its lowest since Dec. 11. Option barriers were cited at $1.2950 and $1.2900.
"When you look across Europe, you see high unemployment, barely any growth, apart from Germany, and rising debt levels," said Howard Jones, advisor at money mangers RMG Wealth Management. "What Europe needs is growth, easier monetary conditions and a weaker currency."
"The US data in comparison is much better than Europe and to us, the dollar is a buy. We expect the euro to ease towards the mid-$1.20s in the next two months."
Speculation that the ECB may cut rates in coming months gathered pace after benign euro zone inflation data. That talk along with renewed worries about rising borrowing costs for struggling euro zone countries would make the euro a sell into rallies, analysts said.
"We are recommending clients to cautiously scale in long euro/dollar positions at this level. But we should not fool ourselves, this (Italian situation) could still go really bad," said Arne Lohmann Rasmussen, head of FX research at Danske Bank.
DOLLAR ON TOP
A last-ditch deal to avert the US budget cuts, due to start on Friday, is seen as highly unlikely.
The International Monetary Fund said it would probably cut its US and global growth forecasts if those automatic spending cuts take effect on Friday, and warned that the United States' biggest trading partners would be hardest hit.
Despite the spending cuts hurting growth in the United States, the economy is not expected to perform as badly as the euro zone, Britain and Japan, which are all battling recession or deflation, giving the dollar a boost.
Investors will focus on the Institute for Supply Management's February manufacturing index and after a robust rise in factory activity in the Midwest, analysts said there was a chance of a good reading. The United States is also scheduled to release personal income and consumption data for January at 1330 GMT.
Good numbers could prove dollar positive.
"The end of 2012 has likely seen the low in real US yields. This suggests the Fed is unlikely to do further easing measures," Deutsche Bank said in a note.
It added that even if the Fed did ease more, other central banks like the Bank of Japan were catching up with Fed easing, pushing down the value of their currencies against the dollar.
The dollar rose to a three-month high against the Swiss franc and was up 0.2 percent at 92.85 yen.
It also rose to a 2-1/2 year high against sterling after a shock contraction in manufacturing activity in February raised expectations that the Bank of England could announce fresh monetary easing as early as next week.
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