Dollar steadies after data shows US economy stable

By Rika Otsuka

TOKYO, Dec 29 (Reuters) - The dollar steadied on Friday after paring losses against the euro in the previous session on a raft of data that showed the U.S. economy may be in better shape than earlier thought.

The U.S. currency has been unable to shake off market expectations in the past few months that the slowing economy could force the Federal Reserve to start cutting interest rates next year.

The dollar fell on Thursday after Yves Mersch, a member of the European Central Bank Governing Council, said euro zone rates remain low in historical terms, highlighting the risk that the dollar's rate advantage could narrow further.

Stronger-than-expected monthly readings for existing home sales, consumer confidence and the Chicago manufacturing index helped the dollar to trim losses against the euro on Thursday.

"It is rather puzzling that market participants are not buying the dollar much despite the strong data," said a trader at a big Japanese bank.

"Players are staying bearish on the currency," he added.

The euro edged up to $1.3162 by 0500 GMT from $1.3150 in late U.S. trading on Thursday.

The dollar was steady at 118.91 yen , little changed from late New York trade on Thursday. It stayed in sight of a two-month peak of 119.23 yen marked on Tuesday.

The euro edged up to 156.54 yen , near a record high of 156.73 yen hit on Thursday.

Market activity in Tokyo was subdued on Friday, after many Japanese companies finished this year's business on Thursday, traders said.

No major economic indicators are due from Japan or the United States, while Germany's GfK consumer sentiment survey for January will be released at 0700 GMT.

Bond and stock markets in Japan were open for a half-day on Friday and will resume trading on Thursday, Jan. 4.

HIGH-YIELDERS BENEFIT

Expectations that the ECB will further boost rates next year from the current 3.5 percent helped the euro to find favour.

"It is easy for investors to chase the euro as it is clear that the currency's yield will continue to rise," said Nobuo Ibaraki, forex manager at Nomura Trust and Banking.

The euro has risen 11 percent against the dollar and 12 percent versus the yen this year, aided by stagnating rates in the United States since mid-year and prospects for only a gradual rise in Japanese rates from the current 0.25 percent.

Despite expectations that the Bank of Japan will bump rates up to 0.5 percent before the end of March, few in the market believe the yen's yield disadvantage will shrink quickly.

Investors' demand for higher-yielding currencies buoyed the Australian and New Zealand dollars on Friday.

The Aussie struck a fresh 9-1/2-year high against the yen , while the kiwi scaled a one-year peak against the yen and matched a one-year high versus the dollar hit on Thursday.

Sterling hovered close to eight-year highs against the yen .

Expectations in the market that the Bank of England may push rates higher in 2007 has helped sterling climb 14 percent against the dollar this year.

A spike in the Chinese yuan that appeared to bring it to par with the Hong Kong dollar on Friday was in fact a mistyped price quotation, an official with the China Foreign Exchange Trading System said.

Earlier, the price quote had indicated that the Chinese yuan had reached parity with the Hong Kong dollar for the first time since 1992.