Dollar on track to rack up strongest year since 2005

LONDON: The dollar was set to end 2014 with a gain of more than 12 percent against a basket of major currencies on Wednesday, its strongest year in almost a decade and, according to most major banks, just a prelude to a further rise next year.

Year-end adjustments to market positions helped the yen and the euro in thin trade over the Christmas holidays, but the euro is expected to fall below $1.20 in the first quarter.

The dollar index, which measures its value against a basket of six major currencies, last stood unchanged at 89.920 . This year, though, the dollar should see its largest gain since it climbed nearly 13 percent in 2005, and only the third year in 30 when it has gained more than 10 percent.

The contrast between the U.S. Federal Reserve's path towards raising interest rates next year and looser monetary policies in the euro zone and Japan was the driving force behind the dollar index's rise to its highest in more than 8 1/2 years on Tuesday.

"The U.S. economy has outperformed on a relative basis all the other major economies and that's prompted the market to increase expectations that the Fed will raise rates some times in the middle of next year," said Lee Hardman, a currency economist at Bank of Tokyo-Mitsubishi UFJ in London.

"The monetary policy divergence between the Fed and the other major central banks will likely widen, so that makes the stronger dollar case even more compelling next year."

However, the dollar has come a long way in a hurry. It is not clear whether further gains in the first half of next year might put the Fed off raising rates.

Also, turbulence may grow in developing markets, especially China. Political turmoil could again threaten Greece's presence in the euro, adding to concern over growth and the balance of the global financial system. Such threats prodded investors towards the safety of the yen this week.

Still, the dollar has risen more than 13 percent versus the yen this year. The gains accelerated as an election strengthened the mandate for Prime Minister Shinzo Abe's policy of flooding the market with yen.

For 2015, "if you ask whether the dollar is likely to head in the direction of 100 yen or head toward 130 yen, I think it will be the latter," said Teppei Ino, an analyst for Bank of Tokyo-Mitsubishi UFJ in Singapore.

By 1150 GMT, the euro was steady at $1.21565. Against sterling, the single currency hit a three-month low of 77.825 pence, down a third of a percent on the day.