* Money market squeeze, ECB shift fuel dollar surge
* Dollar index up 3.85 pct on week.
* ECB poised to join other major c.banks in cutting rates
* Yen surges as market players unwind stale carry trades
By Eric Burroughs
TOKYO, Oct 3 (Reuters) - The dollar hovered near a one-year
peak against a basket of major currencies on Friday as banks and
financial institutions have scrambled to buy the U.S. currency
after being locked out of frozen money markets.
The dollar held gains scored versus the euro the previous
day after European Central Bank President Jean-Claude Trichet
said inflation risks have eased, bolstering expectations the ECB
will follow other major central banks in cutting rates.
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So far on the week, the dollar has soared 3.85 percent
against the basket of six major currencies, its biggest weekly
rise in 16 years.
Traders and analysts said the severe squeeze in interbank
lending -- which has driven three-month dollar LIBOR rates
<USD3MFSR=> up a full percentage point in two weeks to more than
double the Federal Reserve's 2 percent rate target -- was a
major factor behind the dollar's gains.
"It's all about fear, the next shoe to drop, and it looks
like it's going to be in Europe," said a senior currency trader
at a U.S. investment bank in Hong Kong. "Europeans are paying a
dear price to fund themselves in dollars, and that's behind the
dollar's rise."
The trader said that if money market conditions do not begin
to thaw after the expected passage of the $700 billion bank
bailout plan in the U.S. House of Representatives on Friday,
then market players will look for coordinated central bank rate
cuts.
The crisis of confidence among banks after the demise of
Lehman Brothers and troubles at other major financial firms has
caused interbank lending to all but dry up, leaving many players
desperate for dollar funding wherever they can get it.
"There is the added element of dollar buying, regardless of
the level, by people facing funding strains," said a senior
trader for a major Japanese trading house.
Societe Generale's FX sales desk told clients that "the
underlying market theme is the dollar funding story."
The euro rose around 0.3 percent from late U.S. trade to
$1.3862 <EUR=>, recovering from an initial dip near the 13-month
trough of $1.3747 struck on trading platform EBS on Thursday.
The single currency rose 0.3 percent to 146.00 yen
<EURJPY=R> after sliding to a two-year trough of 144.56 yen at
one point. The dollar was little changed at 105.24 yen <JPY=>.
The dollar index, which gauges its performance against a
basket of six major currencies, dropped 0.3 percent to 80.244
<.DXY> after reaching a one-year peak of 80.794 the previous
day.
Trichet and other officials rejected any need for a European
rescue fund for banks suffering from the credit crisis as French
President Nicolas Sarkozy prepared to host a summit on the
crisis in Paris. []
A slew of economic data this week showing the U.S. economy
has likely fallen into a full-blown recession has done little to
take the wind out of the dollar's rise, even as the Fed is seen
likely to cut rates as well this month.
While the dollar has powered higher, so has the yen as the
crisis has prompted market players to still unwind stale
positions favouring carry trades -- using the low-yielding
Japanese currency to buy higher-yielding currencies.
The euro tumbled to a two-year low against the yen, while
the Australian dollar slid near a three-year trough touched the
previous day.
The Fed's dollar trade-weighted index against major
currencies rose 2 percent in September, but the Bank of Japan's
trade-weighted index showed the yen gained 4.4 percent the same
month.
(Additional reporting by Masayuki Kitano; Editing by Chris
Gallagher)
