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Euro rallies, closes up after ECB rate hike

NEW YORK: Fresh from a string of heavy losses, Europe's single currency staged a smart rally on Thursday after Europe's central bank surprised financial markets with an interest rate hike.

The embattled euro gained nearly 1-1/2 percent against the dollar, rose almost 1 percent against the yen and shot up nearly 2 percent against the British pound.

In its wake, the Swiss franc also surged, rising nearly 1-3/4 percent against the dollar after the Swiss National Bank also tightened credit.

"The market's reaction to the rate news is better than I would have expected said Eric Nickerson, currency strategist at Bank of America.

Meeting one day after the Federal Reserve raised short-term borrowing costs in the United States to combat rising price pressures, the Frankfurt-based European Central Bank did the same and lifted its key refinancing rate a quarter point to 3.25 percent.

ECB President Wim Duisenberg told a news conference the decision was based on an assessment of medium-term risks to price stability and added the euro's fall contributes to a rise in import prices.

"The development of the exchange rate was not a decisive move that tipped the scale ... but of course, in our decision today, we carefully looked at the development of the exchange rates" Duisenberg said.

Although the euro initially dipped after the news as dealers worried the bank may be choking off the region's fragile recovery, it then rebounded sharply.

Dealers called the move a classic short squeeze, occurring after the euro ploughed through technical resistance just above 98 cents to reach levels above 99 cents. The euro closed just one cent shy of the psychologically key one-to-one level with the dollar.

But dealers were sceptical about whether the euro could hold its gains, saying the interest rate differential between the US and Europe still worked in favour of the dollar.

The euro had lost more than 18 percent in value since its launch in January 1999 but has surged nearly 2-1/2 percent since Tuesday, when it hit a record low of 96.60 cents.

On the heels of the ECB's move, the Swiss National Bank raised its target range for three-month Swiss London Interbank Offered Rate by half a point to 1.75 to 2.75 percent from 1.25 to 2.25 percent.

The SNB said the the move was aimed at countering weakness in the franc, which was threatening price stability. On Monday, the Swiss franc had slumped to 10-year lows versus the dollar.

Meanwhile, the dollar sagged against the Japanese yen, completely erasing its overnight gains and shedding about half a percent to stand at 107.56 yen.

Overnight comments from senior Finance Ministry officials that they remained concerned about the effect of the strong yen on Japan's economy gave the dollar some support.

The dollar had survived the Fed's quarter-point rate hikes on Wednesday with technology shares leading a rally on Wall Street. -Reuters