Euro firms in post-Christmas trade, dollar down

LONDON, Dec 27 (Reuters) The euro hit a 6-1/2 year high versus the Swiss franc and jumped against the dollar in thin post-Christmas trading on Wednesday, buoyed by expectations that euro zone interest rates are set to rise further in 2007.

In the absence of major economic data, investors focused on the diverging interest rates outlook, where expectations still linger for interest rate cuts in the United States.

The euro has enjoyed an upper hand against the Swiss franc in recent weeks as the Swiss National Bank slashed its 2007 interest rate outlook after raising rates earlier this month.

''It's still a yield differential story between the euro and the Swiss franc. We think SNB will hike in March of next year but we also expect the ECB to continue hiking so the interest rate differential will not narrow,'' said Marcus Hettinger, global FX strategist at Credit Suisse in Zurich.

The euro rose as high as 1.6059 Swiss francs, up 0.15 percent on the day.

The single currency was up 0.5 percent at $1.3158 by 1202 GMT, while it hit a one-month high against the Norwegian crown as oil prices fell sharply on concerns about mild weather.

The dollar was down almost half a percent at 118.60 yen, while the euro was steady at 156.08 yen, off last week's record high around 156.45.

The European Central Bank is expected to raise interest rates further next year from the current 3.5 percent.

US RATES OUTLOOK Softer than expected U.S. data in recent weeks has boosted speculation the Federal Reserve might cut rates from the current 5.25 percent. Wednesday brings U.S. November new home sales numbers at 1500 GMT, preceded by revised building permits figures at 1330 GMT.

''This whole sentiment building up for a potential rate cut in the United States has been dollar-negative and it's still there,'' said Naeem Wahid, currency strategist at Halifax Bank of Scotland Treasury Services.

The Mortgage Bankers Association said U.S. mortgage applications plummeted last week to the lowest level in nearly five months, dragged down by a plunge in demand for home refinancing loans.

Data on the U.S. housing market is seen key in determining if and when the Fed would begin cutting interest rates.

Having spent much of the year stuck in ranges, the dollar plunged in November on expectations of U.S. rate cuts and speculation of central banks diversifying out of dollars.

Sterling has been the main beneficiary, with its year-to-date gains at nearly 14 percent. The euro has gained 11 percent against the dollar and yen this year.

With a largely empty data and financial events calendar, analysts said markets were likely to remain jittery and volumes thin in the final week of the year.

Telecommunications around Asia were severely disrupted after earthquakes off Taiwan damaged undersea cables, hindering financial transactions.

BOJ OUTLOOK The yen edged away from this week's two-month low against the dollar and Japanese government bond yields surged after Jiji news agency reported late on Tuesday that the Bank of Japan is likely to discuss raising rates to 0.5 percent next month.

Jiji, citing no sources, added that the decision could be postponed to February or later in the event of anything unexpected happening in financial markets.

''There was a bit of a turn in the yen that may have been the catalyst for more dollar weakness,'' said Daragh Maher, currency strategist at Calyon.

Elsewhere, the Icelandic crown briefly hit 5-month lows against the dollar and euro, extending losses made last week after Standard & Poor's downgrade the country's ratings, citing a risk of a hard landing in the economy.

REUTERS PKS PM1758