By Anirban Nag
LONDON (Reuters) - The dollar hovered near a seven-week high against the euro on Friday as solid U.S. data fanned expectations of an upbeat jobs report which could pave the way for the Federal Reserve to begin unwinding monetary stimulus this month.
In contrast, the euro was struggling not just against the dollar but against the yen and the British pound after the head of the European Central Bank said the bank was ready to cut official interest rates and inject more funds into the banking sector to keep market rates low.
The two-year U.S. Treasury yield rose to its highest since May 2011, at 0.5217 percent, and the gap over similar dated German bonds widened to its highest since late July. The dollar index has a good correlation with the two-year U.S. yield.
Other U.S. yields have also been rising steadily, aiding the dollar. The 10-year benchmark yield touched 3 percent on Thursday, its highest in more than two years.
U.S. nonfarm payrolls data for August are due at 1:30 p.m. They are expected to show employers added 180,000 jobs in August, and a higher figure would cement the case for the Fed to start withdrawing stimulus later this month.
The euro traded flat at $1.3123, near Thursday's seven-week low of $1.3110 with traders citing a reported option barrier at $1.3100. The dollar index was at 82.524, not far from a recent seven-week peak of 82.671.
"A strong U.S. jobs report, say 200,000 or more, in our view will drive U.S. yields higher and support the dollar," said Bernd Berg, global currency analyst at Credit Suisse. "While it will head higher against the euro, we think the impact will be felt more in the dollar/yen."
He expected dollar to rise past 100 yen if the data beats expectations. Rising U.S. yields would be expected to lure more Japanese investors into higher-yielding U.S. Treasuries.
The prospect of the Fed withdrawing some of the flood of cheap dollars which has benefitted emerging markets since 2009 has prompted a round of soul-searching and policy discussions among leading developing nations.
More gains for the dollar could spell trouble for more exposed currencies like the Indian rupee or Turkish lira.
Against the yen, the dollar hit a six-week high of 100.24 yen in early Asian trade before cautious Japanese exporters took that opportunity to convert dollars to yen just in case the U.S. payrolls data disappoints. The dollar was last trading 0.4 percent lower at 99.70 yen.
One factor that could act against the dollar and in favour of the yen is a possible fall in Japanese shares if Tokyo is not selected by the International Olympic Committee this weekend to host the 2020 Summer Games. That might see Japanese funds shift more cash into bonds and safe havens like the yen.
The near term focus, though, was on the U.S. jobs data and a slew of recent data has bolstered the case for a strong number.
"We expect the Fed to start tapering its stimulus unless today's payrolls report is exceptionally weak," said Shin Kadota, FX strategist at Barclays.
(Additional reporting by Hideyuki Sano; Editing by Patrick Graham)