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Dollar surges on Bernanke inflation comments

LONDON - The dollar rose broadly, setting a three-month high against the yen on Tuesday, after Federal Reserve Chairman Ben Bernanke raised his anti-inflationary language, stoking expectations for U.S. interest rate rises.

Bernanke said on Monday that the central bank would strongly resist rising inflation expectations and that the latest surge in energy prices added to dangers from price pressures.

He also said the risk of a substantial downturn in the U.S. economy had receded, sparking broad dollar gains and sending U.S. bond yields soaring. (For details please double click on).

Bernanke's remarks came in the wake of last week's ultra-hawkish words from European Central Bank chairman Jean-Claude Trichet, signalling a near-term ECB rate hike to combat soaring euro area inflation.

"It's become clear that dealing with the side effects of currency volatility is not enough and that central bankers need to attack the source of the problem - i.e. oil prices," said Lena Komileva, G7 market economist at Tullett Prebon.

"There's implicit concern about currency levels. I think the Fed appreciates there's a high risk that if the ECB were to deliver tightening, as they threatened last week, the implications for a weak dollar and higher oil prices...would be ultimately detrimental both for the Fed's credibility and health of the U.S. economy," she added.

The interest rate futures market is now pricing in almost 70 basis points worth of rises in U.S. rates from the current 2 percent by the end of the year.

By 1016 GMT, the dollar was up 0.6 percent to 107.01 yen, having earlier hit its highest in over three months at 107.13.

The euro was down 0.9 percent at $1.5497 while the dollar also gained 0.8 percent against a basket of currencies to 73.474 .

Inflation busters

The dollar began to rally on Monday, before Bernanke's comments, after U.S. Treasury Secretary Henry Paulson declined to rule out market intervention and New York Fed President Timothy Geithner said the central bank was paying close attention to the dollar.

Bernanke shocked markets last week by saying a weaker dollar was adding to inflation risks -- a rare departure from normal policy of not commenting on the dollar -- which began to raise speculation about intervention.

Bernanke was effectively eclipsed by Trichet's explicit comments on euro area interest rates, but came back to the fore again this week, showing that top policymakers are trying to limit the inflationary impact from oil rising to nearly $140 a barrel ahead of this weekend's G7 meeting in Japan.

"With currency-supportive comments by the world's most important central bank governors coming in quick succession, there is a suspicion that policymakers are co-ordinating their verbal rhetoric to anchor inflation expectations without destabilising their own currencies," UBS said in a note to clients.

Highlighting the sudden shift in expectations on the Fed policy outlook, the two-year U.S. Treasury yield soared as much as 25 basis points on Tuesday to a high of 2.966 percent -- nearly a percentage point above the Fed funds rate of 2.0 percent.

The euro shot higher last week after Trichet said a number of policymakers wanted higher rates and an increase from the current 4.0 percent was possible next month. He repeated the message on Monday.