Dollar holds gains, Fed seen steady on rates

TOKYO, Nov 17 (Reuters) The dollar on Friday held to gains scored after U.S. data the previous day showed a slowdown in inflation and a rebound in regional factory activity, reinforcing views that the Federal Reserve will keep interest rates steady.

The dollar had slid against European currencies last week, hitting a 2-1/2-month low against the euro and an 18-month low against the pound on expectations that the European Central Bank and Bank of England would keep lifting rates.

But the dollar has managed to claw back this week, with the economy seemingly headed for a soft landing and the Fed seen maintaining the U.S. currency's 5.25 percent rate, higher than the euro's 3.25 percent and sterling's 5.0 percent.

''The recent spate of weak U.S. data do not indicate to us that the U.S. economy is headed for a drastic slowdown,'' said currency strategists at JPMorgan Chase in a note to clients.

With the market locked in tight ranges, the drop in volatility has prompted investors to sell low-yielding currencies like the yen to fund purchases of higher-yielding currencies in the carry trade.

The dollar was little changed from late New York trade near 118.25 yen after climbing as high as 118.35 yen on Thursday, near this month's peak of 118.60 yen.

The euro changed hands at 151.22 yen after having matched an all-time high of 151.48 yen overnight.

The single currency slipped slightly to $1.2785 off the 2-1/2-month peak of $1.2901 struck last week and still mired in a broad range over the past six months between $1.25 and $1.30.

The pound was at $1.8875 Sterling has lost more than 1 percent this week as soft economic data and the Bank of England's quarterly inflation report stoked worries the BoE may be done raising rates.

Sterling remains one of the best-performing major currencies this year, up 10 percent against the dollar thanks to inflows into Britain from mergers and acquisitions, shifting of reserves by central banks and the BoE's rate increases.

Thursday's batch of U.S. data showed the core consumer price index slowing to a 2.7 percent year-on-year pace in October, down from a decade-high 2.9 percent in September and suggesting that the energy-driven jump in inflation may be reversing.

Another report suggested that the U.S. economy is holding up despite a sharp housing market slowdown. The Philadelphia Fed's index showed Mid-Atlantic manufacturers posted slight growth in November after a two-month contraction.

Earlier this week the minutes of the Fed's October meeting indicated that policy makers felt inflation was still a risk and were leaning towards raising rates again, even as investors believe the central bank's next move will be a rate cut in 2007.

Chicago Fed President Michael Moskow said on Thursday it was too soon to say if the central bank had ''broken the back'' of inflation.

REUTERS PDS PM0748