(Adds comments, closing prices, changes byline)
* Euro hits 3-week high amid talk of ECB rate hike
* Mixed U.S. inflation data clouds interest rate outlook
* Credit fears, high oil adds to unease, uncertainty
By Vivianne Rodrigues
NEW YORK, May 20 (Reuters) - The dollar fell on Tuesday as
talk of higher euro zone interest rates prompted investors to
increase exposure to the euro, though losses were capped by
inflation data that muddied the U.S. interest rate outlook.
Concern about further credit-related losses and their
impact on financial markets also sent the dollar tumbling
against the low-yielding yen and Swiss franc, while a record
high in oil added to fears about surging price pressures.
That has led to choppy trading conditions, with prices
whipping around for most of the global session.
"It's been difficult to trade, as volumes have been fairly
light, but the main driver has been interest rate expectations
moving in the euro's favor again," said Benedikt Germanier,
senior currency strategist at UBS in Stamford, Connecticut.
The euro rose earlier to a three-week high of $1.5679
<EUR=> after an adviser to the German government said the
European Central Bank may soon raise interest rates. It last
traded at $1.5663, up 1 percent from late Monday.
The remarks from Wolfgang Franz, the president of the ZEW
economic research institute, offset the second straight monthly
decline in the ZEW's investor sentiment survey and dovetailed
with a separate report showing German producer price inflation
at a 20-month high.
"The inflationary pressures in Europe are relentless and
that's driving the euro higher, and the slowdown is relatively
mild," said Boris Schlossberg, senior currency strategist at
DailyFX.com in New York.
Sterling rose 1 percent to $1.9684 <GBP=>, while the dollar
fell 0.7 percent to 103.62 yen <JPY=> and 1.6 percent to 1.0358
Swiss francs <CHF=>, with analysts pointing to concern about
the credit crunch.
Meredith Whitney, a U.S. banking analyst at Oppenheimer &
Co, said the crisis would extend into 2009 and beyond, setting
up three years of multibillion-dollar revenue losses.
There was little reaction in currency markets to the Bank
of Japan's decision to keep its borrowing costs on hold at 0.50
percent, as expected, on Tuesday. []
The ECB has held its benchmark rate at 4 percent since last
June as record oil prices have pushed inflation higher. The
Federal Reserve, by contrast, has slashed rates from 5.25
percent to 2 percent since September but has since signaled a
pause in its rate-cutting campaign.
Tuesday's data on U.S. producer prices complicated the
outlook. Overall prices advanced less than expected, but core
inflation, which strips out volatile food and energy prices,
rose by a larger-than-expected 0.4 percent.
"The situation with inflation is just very serious and
shows no sign of abating any time soon," said Lena Komileva,
head of G7 Market Economics at Tullett Prebon.
Fed Vice Chairman Donald Kohn said on Tuesday that rates
seem to be at the right level to support growth without
boosting inflation. But he added that officials must be ready
to adjust rates quickly if the outlook changes.
"Kohn sounded more neutral than dovish to me, and with a
falling dollar and rising oil prices, (higher) inflation
expectations are a risk, and they need to monitor that
closely," Germanier said.
Crude surged to a new record above $129 <CLc1> on Tuesday,
boosted partly by the weak dollar and fears that high global
demand will strain supplies.
Schlossberg said a strong reading on Wednesday in the Ifo
survey of German business sentiment could push the euro back
toward all-time highs above $1.60.
(Additional reporting by Steven C. Johnson; Editing by
Jonathan Oatis)
