* Dollar broadly weaker as Fed rate hike outlook clouded
* Euro surges as markets brace for ECB to hike in July
* Euro notches record high against battered yen
(Updates prices, adds comment, adds U.S. data, changes
dateline, changes byline)
By Steven C. Johnson
NEW YORK, June 26 (Reuters) - The dollar fell broadly on
Thursday, nearing a three-week trough against the euro after
the Federal Reserve held interest rates at 2 percent and dashed
expectations of an imminent rate hike.
While the Fed said inflation risks had increased, it did
not use language that convinced markets a rate hike was likely
at its next policy meeting in August.
The European Central Bank, however, has repeatedly said it
may lift rates in July to fight inflation, helping to push the
euro near a three-week high at $1.5747 <EUR=> before easing to
$1.5725, up 0.4 percent from late Wednesday.
The dollar also fell 0.4 percent to 107.44 yen <JPY=>,
while sterling rose 0.7 percent to $1.9880 <GBP=>, just below
an eight-week high hit earlier in the session.
"The dollar is on the ropes and has further to fall unless
the Fed can correct the market perception that U.S. rates are
on hold indefinitely," said Michael Woolfolk, senior currency
strategist at The Bank of New York Mellon.
With the ECB "clearly focused on inflation and willing to
sacrifice growth to keep it at bay," he said the euro is likely
to break its all-time record above $1.60 in the near term.
The euro also climbed to a record high at 169.45 yen
<EURJPY=>. The Japanese currency has been hurt by expectations
that the Bank of Japan will keep interest rates at a low 0.5
percent for a while due to weakness in the domestic economy.
Strategists said Fitch Ratings' move to lower the credit
ratings of General Motors <GM.N> and Chrysler LLC <CBS.UL>,
citing weaker sales, high fuel costs and a sluggish U.S.
economy, also hurt the dollar.
The U.S. central bank's move to leave interest rates
unchanged on Wednesday effectively ended one of its most
aggressive rate-cutting campaigns to limit the economic fallout
from the housing and credit crisis.
Rising inflation expectations, though, have many investors
worried that the Fed is falling behind the curve. Oil prices on
Thursday were up more than $3 above $138 a barrel <CLc1>.
"Wishing away inflation is not a prudent policy move if you
are a central banker, and we fear the Fed is going to run afoul
of its dual mandate, which includes price stability," Woolfolk
said.
Expectations for a July ECB hike remained intact after data
from German states pointed to an increase in inflation in the
euro zone's biggest economy.
Euro/dollar has been trapped in a $1.5285-$1.5844 range for
about two months, but some analysts said the near-term outlook
for the pair remained bullish.
"The market is dealing in hard facts, and the ECB is very
likely to be raising rates next week and probably still
sounding pretty hawkish even after they've hiked," said Chris
Turner, head of FX strategy at ING in London.
Data showing the U.S. economy grew by 1 percent in the
first three months of the year, up from just 0.6 percent in the
fourth-quarter of 2007, provided a bit of cheer to the U.S.
outlook but had limited impact on currency prices.
A separate report due at 10 a.m. (1400 GMT) is expected to
show a slight improvement in U.S. existing home sales last
month.
(Additional reporting by Michael Taylor in London; Editing by
Jonathan Oatis)
