Dollar ends year up 15% against euro

THE dollar gained against the euro and yen in 2005, rising about 15% versus both currencies as the US interest-rate gap widened with Europe and Japan.

The US currency saw its biggest annual rally versus the euro since 1999, the year the 12-nation currency was introduced, and the first in four years. The Federal Reserve raised its target rate eight times while the European Central Bank lifted its key rate once and the Bank of Japan held rates at zero percent. The Fed has raised rates 13 times since mid-2004.

“The dollar is firmer this year because interest rates have moved more in the dollar’s favour than anticipated earlier this year,” said Daniel Katzive, a currency strategist at UBS.

The dollar rose to $1.1849 per euro at the close of business in New York last Friday, up from $1.3554 at the end of 2004.

Fed policy makers are expected to lift rates twice more by June, to 4.75% from 4.25%, and the ECB will boost borrowing costs once to 2.5% from 2.25%, Bloomberg surveys show.

“Until it becomes clear the Fed is finished tightening rates, I don’t think we will see a change in the trend,” said Richard Grace, a senior currency strategist in Sydney at Commonwealth Bank of Australia.

The yield premium on US bonds over European and Japanese debt widened to the most in at least four years in 2005. Two-year Treasuries yielded 4.11 percentage points more than similar-maturity Japanese government bonds.

“Yields were very important in 2005; we think they’ll be important again over the early part of 2006,” said Nick Bennenbroek, a currency strategist at Brown Brothers Harriman & Co in New York. “Over the first half of the year we think the dollar will do a little better on interest rates.”

The dollar’s rally this year wasn’t anticipated by the biggest traders in the currency market, who predicted the dollar would weaken for a fourth year because of a widening current account deficit.