* Euro firmer on ECB rate hike expectations
* Euro seen benefiting from diversification flows
* Yen steady, focus on Japan's nuclear crisis
By Natsuko Waki
TOKYO, March 29 (Reuters) - The euro rose against the dollar
on Tuesday after comments by the head of the European Central
Bank the previous day reinforced expectations for higher
interest rates, while the yen held steady with the focus on
Japan's nuclear crisis.
ECB President Jean-Claude Trichet said on Monday inflation
in the euro zone is "durably" above the ECB's target, cementing
expectations that the central bank would raise interest rates
next month.
His comments also helped relieve pressure on the single
currency from the euro zone debt crisis, with concerns rising
about Portugal's ability to finance itself.
"Investors are focused on inflation expectations in the euro
zone. An April hike may be a done deal, although there's still
some uncertainty about what's going to happen beyond that," said
Masafumi Yamamoto, chief currency strategist at Barclays
Capital.
"A recent rise in oil prices is also raising expectations
that oil producers will diversify away from the dollar, which
would also benefit the euro."
The euro rose 0.1 percent on the day to $1.4101 ,
moving away from the previous day's 1-1/2 week low around
$1.4020.
Reflecting rising rate hike expectations, key euro-priced
interbank lending rates rose to a 22-month high on Monday with
the level of excess liquidity in money markets
falling.[]
The European single currency is one of the best performing
currencies against the dollar this year, having risen 5.4
percent since January. The euro's resistance levels are seen at
$1.4220 and $1.4248.
The dollar was slightly weaker at 81.67 yen , having
fallen to 81.51 earlier as the discovery of plutonium in soil at
the quake-hit Japanese nuclear plant soured risk sentiment.
The low-yielding yen tends to rise in times of risk aversion
because Japan's current account surplus puts upward pressure on
the yen in the absence of portfolio outflows into risky overseas
assets.
A customer dealer for a major Japanese bank in Tokyo
reported a significant amount of dollar offers, mainly from
Japanese exporters, at and above 82 yen -- the March 18 high hit
after coordinated G7 intervention to curb the yen at Japan's
request.
He said the dollar is vulnerable to a fall towards 80.80.
Analysts say players would be reluctant to push the dollar
below 80 yen on worries about further intervention.
Others also reported talk that Japanese exporters may have
over-hedged for the April-June period following production and
sales cuts, a factor which could also weigh on the yen.
QE2 ENDGAME
Following hawkish comments by the Federal Reserve last week,
interest rate differentials widened in favour of the dollar
against the yen.
But that rate support for the dollar waned after another Fed
official said on Monday that the U.S. economy still needed
support from the central bank's full $600 billion planned bond
purchases [].
"The likely dip in confidence in the wake of the Japan
earthquake and evidence of deepening housing deflation can both
serve as reminders that the majority of FOMC members are
unlikely to consider current economic performance good enough to
meet the hurdle rate for a premature end to QE2," BNP Paribas
said in a note to clients.
The dollar index , which tracks the U.S. currency's
performance against a basket of major currencies, was slightly
higher on the day at 76.150.
The two-year U.S. Treasury yield had risen to a three-week
high at 0.785 percent at one stage, up more than 14
basis points in five days, widening its gap over comparable
Japanese yields.
Preliminary estimates from Citi's month-end hedge
rebalancing model suggested foreign buying of Japanese yen may
dominate the March month-end fix.
Citi said Japan's March 11 earthquake and subsequent nuclear
crisis had hit local equities hard, leaving foreign investors
over-hedged. This means that passive index-following investors
may need to buy the yen at the month-end to reduce the value of
their hedges.
In other currencies, the signals pointed to net dollar
buying against the euro and sterling.
(Additional reporting by Masayuki Kitano; Editing by Michael
Watson)
