LONDON, Apr 7 (Reuters) The euro edged further away from seven-month highs versus the dollar and record levels against the yen on Friday, after the head of the European Central Bank poured cold water on market expectations of a May rate hike.
ECB President Jean-Claude Trichet surprised investors on Thursday, following the bank's decision to hold interest rates at 2.5 percent, when he said the ECB disagreed with markets which had priced in a 100 percent probability of a move next month.
This triggered a sell-off in the euro, but clear hints by the ECB chief that another rate rise could come in June reassured investors that they were not wrong to expect the bank's gradual monetary tightening to continue.
''It's clearly shifted the market expectations from a May move to a June move. Our outlook is really unchanged that the ECB will be on a gradual tightening path into 2007 with rates probably peaking at 3.25 percent,'' said Adam Baines, currency strategist at Citigroup.
By 0805 GMT, the euro had weakened 0.3 percent on the day to $1.2180, well off a seven-month peak of $1.2333 hit before the ECB's remarks on Thursday.
It was down nearly half a percent at 143.25 yen, having on Thursday hit its highest level since the launch of the single currency in January 1999 at 144.92.
Euro selling continued as some market players also sought to reduce their long-euro positions ahead of a U.S. employment report due at 1230 GMT.
Economists in a Reuters poll expect the non-farm payrolls data to show a gain of 190,000 jobs in March, compared with an increase of 243,000 jobs a month earlier. The unemployment rate is forecast to hold steady at 4.8 percent.
U.S. JOBS REPORT Investors will look to the U.S. payrolls data to gauge the state of the U.S. economy and for clues on how much longer the Federal Reserve wil continue its monetary tightening campaign.
Recent comments by Fed officials have fuelled speculation that the end of a nearly two-year long tightening policy could be in sight, putting pressure on the dollar. The Fed has raised rates 15 times since mid-2004, pushing its funds rate to 4.75 percent.
Adding to the dollar's woes, Chicago Fed President Michael Moskow said on Thursday the United States faces a risk that Asian central banks which are still hungry for U.S. assets will one day reach their limit and reinvest at home.
Talk of diversification out of dollars in Asia and the Middle East had put an extra burden on the dollar earlier this week.
The dollar was little changed versus sterling at $1.7510 and 0.14 percent weaker against the yen at 117.59.
Nevertheless, the dollar was seen firmly supported between 115.50 and 119.50 yen -- a range for the past two months that most traders think will persist into the near future.
Counting on such range-bound trade, some speculators have resumed yen carry trades, dealers said. In such trades investors borrow the Japanese currency at near-zero interest rates and invest in higher-yielding currencies, such as the dollar.
''As long as the dollar/yen is stable, it's a good idea to enjoy the interest rate gap'' between the United States and Japan, said Kazushi Awa, manager of forex and investment at Sumitomo Corp in Tokyo.
''The yen has not risen despite the recent sharp rise in Japanese bond yields. That is making many people feel secure about doing carry trades.'' Expectations that the Bank of Japan will start tightening credit in the third quarter of this year have boosted 10-year Japanese government bond yields by about 50 basis points in the past three months.
REUTERS CS PM1435