Oct. 3 (Bloomberg) -- The dollar remained higher against the yen and euro as an index of U.S. manufacturing was higher than forecast in September.

The Institute for Supply Management, a private industry group, said its factory index rose to 59.4 in September from 53.6 in August. Economists expected a reading of 52, according to the median forecast in a Bloomberg survey. Readings above 50 signal growth.

``The market is looking for a reason to extend the dollar's gains,'' said Jeff Gladstein, global head of foreign-exchange trading at AIG Financial Products Corp. in Wilton, Connecticut. The ISM index ``is coming on the heels of much stronger-than- expected Chicago Purchasing Managers'' index of manufacturing last week. Gladstein spoke before the ISM index was announced.

Against the yen, the dollar advanced to 114.17 at 10:03 a.m. in New York, from 113.50 on Sept. 30, according to electronic currency-dealing system EBS. It rose as high as 114.24 today, a level not seen since May 19, 2004. The dollar traded at $1.1926 per euro, from $1.2026, and was higher against 14 of the 16 most active currencies.

The dollar's strength also was fueled by speculation of further interest-rate increases by the Federal Reserve.

San Francisco Fed President Janet Yellen last week indicated rates may rise more than currently forecast.

Fed Bank of Kansas City President Thomas Hoenig on Sept. 26 added to expectations of higher interest rates when he said inflation is ``high enough to get your attention.''

Policy makers on Sept. 20 lifted the interest-rate target for the 11th straight time, to 3.75 percent, and said further increases were likely. The Bank of Japan has kept rates at almost zero since 2001. The next Fed policy meeting is Nov. 1.

Rate Advantage

``The market is focusing on interest rate differentials for the moment,'' said Thio Chin Loo, a senior currency analyst in Singapore at BNP Paribas SA. ``The widening interest rate differentials are indeed weighing on the yen.''

The yen may weaken to 115 per dollar, she said.

The dollar began rising during Tokyo trading earlier today after the Bank of Japan's Tankan survey showed business confidence rose less than economists expected.

``This was a surprise and disappointed the market, leading to yen weakness,'' said Sven Friebe, a currency strategist at Credit Suisse Group in Zurich. ``The move lower in the yen against the dollar has also led to dollar buying across the board.''

The yen extended its decline this year to 10 percent as the Tankan report suggested higher oil costs may erode profits and hurt prospects for sustained growth.

`Discourage Yen Buying'

``This worse-than-expected figure should discourage investors from buying yen,'' said Masaki Fukui, a currency analyst in Tokyo at Mizuho Corporate Bank Ltd., a unit of Japan's second-biggest lender by assets. ``The Japanese economy seems to have not fully stepped out of its soft patch. It's kind of marking time.''

The Tankan index gained to 19 in the three months to the end of September from 18 points in June. The median forecast of 36 economists in a Bloomberg News survey was for 21.

Forty-seven percent of the 55 traders, strategists and investors surveyed on Sept. 30 from Sydney to New York advised buying the yen against the dollar, and 32 percent recommended selling Japan's currency versus the dollar.

Japan's economy expanded at an average annual pace of 4.6 percent in the first six months of this year, the fastest in 15 years. The economy is set to expand for its fourth straight year, the longest expansion since 1997.

To contact the reporter on this story: Jake Lee in London at jlee127@bloomberg.net

Last Updated: October 3, 2005 10:07 EDT