Don't rule out further euro gains

London: The euro's eight-year bull run against the dollar is starting to show real signs of fraying, but analysts are reluctant to rule out another push to the upside even as economic conditions become more challenging.

Prospects for a decisive run above April's record high of $1.6018 have faded in most quarters, but a stab up to the psychological $1.60 level could still happen, even for those expecting the single currency to end 2008 below $1.50.

With inflation rearing up sharply in the single currency zone - due mainly to rampant rises in oil prices - and a well-flagged ECB rate hike to 4.25 per cent, the stage had been set last week for an epic euro/dollar rally.

A Reuters poll taken just a day before last Thursday's expected ECB hike had borne witness to that, concluding that the euro could push to fresh highs if ECB president Jean-Claude Trichet backed up the rate move with continued hawkish rhetoric on inflation.

But "Super Thursday" was quickly deflated as Trichet, having never run shy of stunning markets before, used the post-rate meeting news conference to douse expectations for a series of hikes - causing an outsized 2 cent fall in the euro/dollar rate.

The single currency is still very much in wound-licking territory now, shuttling between $1.56 and $1.57, compared with a 2 month high of $1.5909 before the rate verdict and aftermath.

But several analysts, even those expecting the euro to end the year significantly below current levels, haven't quite called time on the prospect of another hurrah.

"I think the upside in euro/dollar should resurface quite quickly because in terms of monetary policy outlook the ECB should stay a little more hawkish than the Fed ... because of inflation expectations," said Carole Laulhere, currency strategist at Societe Generale in Paris.

The US central bank, coming up for air from an aggressive campaign of interest rate cuts to 2 per cent, has started talking tough on inflation but that has not yet translated into monetary tightening as the US economy is still grappling to emerge from a sharp slowdown.

At the same time, some ECB watchers have noted that the euro area bank is still charged with combating inflation and argue that a retreat in expectations after a hike is not unusual.

"In terms of how the ECB has acted - it's not inconsistent with what we've seen before. The month after it signals it's going to hike, it hikes rates, then it steps back from the hawkish rhetoric to show rates will be on hold in the next month because since 2005 the ECB has never hiked back-to-back," said Kamal Sharma, G10 strategist at JP Morgan.

Oil catalyst

Even though further shocks might be in store for the US, any euro attempt to rise above recent ranges will not be easy as economic data in several euro zone countries, including economic star-pupil Germany, has turned the robust growth picture sour.

In fact, the ECB might well find itself in a similar position to the Fed and even the Bank of England, where inflation and growth are pulling in different directions, making any attempt to adjust monetary policy difficult.

So what would be a catalyst moving the euro higher in a monetary policy stalemate?

Having hit a record high last week near $146 a barrel, the inflationary effect of sky-high energy prices coupled with those of other soaring commodities is set to continue impacting the US dollar for some time yet.

"The continuing rise in the price of oil is adding to upside pressure on euro/dollar," Barclays Capital said in a note to clients.

"In the short-term, euro/dollar seems likely to return within its range of the past two months but we think an eventual move back towards 1.60, and probably temporarily above it, remains likely over the next few months," it added.

Even those with less bullish fundamental views on the euro say the pulling power of oil and continuing US economic difficulties should not be ruled out.

"Once the current (euro/dollar) decline runs out of steam, US data continues to look ugly ... further out the spectre of oil moving up above $150, dragging euro/dollar higher again remains," CBCM analysts said.