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Fed's rate path to define dollar strength in the coming year

[WASHINGTON] With the US Federal Reserve poised to hike interest rates as early as next month, the dollar will rise in the coming year, but by how much will depend on the course of monetary policy, a Reuters poll found.

The driving force behind the dollar's 18-month surge is expectation the US rates will rise this year, even as most other major central banks maintain their accommodative stands.

The dollar index hit a 3-1/2 month high against a basket of currencies early on Wednesday after Atlanta Federal Reserve President Dennis Lockhart expressed support for an interest rate hike in September.

All but four analysts in the poll have penciled in September for when the Fed will lift interest rates for the first time in almost a decade. The remaining four said December.

But the latest poll of more than 60 analysts, taken this week, showed the euro will fall only slightly in the coming year, with only a one-in-three chance for the single currency to fall to or below parity with the dollar.

That suggests much of the shifting landscape for global central banks has already been priced in and instead the path of the Fed's tightening cycle will drive currencies.

"Whether it is September or December will make little difference to the FX market: what matters more is the pace of the tightening cycle," wrote Vasileios Gkionakis, Global Head of FX Strategy at UniCredit. "The timing of the second rate hike may be more important than that of the first, as it should reveal more information about the steepness of the hiking path."

The euro is forecast to trade near its current level of around $1.08 in three months, weaken to US$1.05 in six months and still trade around that level in a year.

That is almost unchanged from a July poll but the latest expectations were driven by analysts' forecasts for the dollar's strength to be more measured going forward. "For the dollar to appreciate from here - or even just sustain current levels - there would have to be a very sharp increase in real rate differentials between the US and the rest of the developed economies," said Mr Gkionakis.

When asked whether the dollar's strength - one of the main reasons behind disappointing US data since the beginning of this year - will get in the Fed's way with its rate hikes over the next year, analysts were split.

Indeed, 15 of 31 analysts said the risk was neutral, eight said high risk, while the remaining eight said low risk.

Outright bets by speculators on either the dollar or euro haven't moved much over the past few weeks. But the biggest change in positioning data was the drop in bets against sterling in the latest week.

The Bank of England is expected to trail the Fed and raise interest rates from record lows early next year.

On Thursday, the BoE will release its latest policy decision, minutes of the meeting and its quarterly inflation and growth forecasts. The message is expected to be clear that policy tightening is not far off.

The poll showed the British pound will hover near its current trading level of $1.56 in a month, $1.53 in six and 12 months, a tad stronger than the predictions in July.

Against other major currencies, sterling is expected to gain. "With a hawkish BoE, the end is near for a singular focus on dollar strength," said Eric Green, head of US strategy at TD Securities.