April 4 (Bloomberg) -- The euro rose to a record against the yen and a two-month high versus the dollar on anticipation the European Central Bank will raise interest rates next month.

The 12-nation currency also got a boost after the United Arab Emirates, Qatar and Kuwait said they may add to holdings of euros in their almost $36 billion in reserves. The euro extended gains after exceeding $1.2208 for the first time since Jan. 27.

``There is likely to be more ECB tightening,'' said David Durrant, an investment strategist in New York at Julius Baer Investment Management, which manages about $38 billion. At the same time, ``the Middle East is going to keep diversifying their reserves.''

The euro climbed to $1.2255 at 5:04 p.m. in New York from $1.2139 late yesterday. The euro advanced to 144.04 yen, from 142.85 yesterday, after earlier reaching the strongest since the euro's January 1999 debut. The dollar fell to 117.54 yen, from 117.68 yen.

Durrant expects the euro to reach $1.24 in three months, its strongest since September.

ECB President Jean-Claude Trichet may signal the central bank is prepared to lift rates further when policy makers meet on April 6, traders said.

The Frankfurt-based central bank, likely to keep its key rate at 2.5 percent at this week's meeting, will increase borrowing costs to 2.75 percent in May, according to the median estimate of 40 economists surveyed by Bloomberg. Trichet will hold a press conference this week after the bank's decision.

`Hawkish Talk'

The ECB is increasingly likely to raise rates in May, Market News International reported today, citing ``well-informed central banking sources.''

``We're probably going to get some hawkish talk out of them,'' said Firas Askari, head currency trader at BMO Nesbitt Burns in Toronto. ``At the end of the day, the Fed is closer to the end and the ECB has a ways to go.''

The euro also extended gains after exceeding 143.50 yen, where traders had euro-buy orders, Askari said. Against the dollar, the euro hasn't closed above $1.22 since January.

The euro climbed 2.3 percent last quarter on expectations the ECB will raise borrowing costs until year-end while the Federal Reserve approaches the end of its rate increases after 15 straight boosts.

Traders ramped up bets the ECB will lift rates to 3.25 percent by year-end, futures prices show. The three-month Euribor contract due December 2006 yielded 3.51 percent, up from 3.2 percent on Feb. 28.

Rate Bets

The contracts, which are traded electronically on the London International Financial Futures Exchange, settle to the three- month euro interbank offered rate, which has averaged 0.16 percentage point above the ECB rate since 1999.

The Fed raised rates on March 28 to a five-year high of 4.75 percent. Futures traders are pricing in a 100 percent chance the central bank will raise its benchmark to 5 percent at its next meeting on May 10. The odds of another boost to 5.25 percent at its June 29 meeting fell to 36 percent, from 38 percent yesterday.

The dollar remained lower after Richmond Fed President Jeffrey Lacker said in a speech that inflation is ``low and stable.'' He spoke in Parkersburg, West Virginia. Lacker is a voting member this year of the central bank's policy-setting committee.

The yield advantage on 10-year U.S. Treasury notes narrowed today relative to debt in Germany. U.S. 10-year notes yielded 103 basis points more than 10-year German bunds, 1 basis point less than yesterday and the least since March 20.

The U.A.E., whose reserves rose almost 30 percent last year, may agree to buy more euros at the central bank's May meeting, Sultan bin Nasser al-Suwaidi, the bank governor, told reporters in Abu Dhabi. Central bank governors of Kuwait and Qatar said they were reviewing the euro's performance.

`Sell More Dollars'

``We sold euros last year when the currency was high, and could buy again,'' Qatar's Central Bank Governor Sheikh Abdullah bin Khaled al-Attiyah said. The emirate's policy is to hold as much as 40 percent of its reserves in euros, and as much as 90 percent in dollars, he said, declining to give further details.

``There's still appetite from central banks around the world to continue to diversify out of dollars,'' said Scott Ainsbury, who helps manage about $12 billion in currency investments at New York-based FX Concepts Inc. ``In the second half of the year when the Fed is done, we'll see some real pressure on the dollar. We're looking to sell more dollars.''

Hong Kong-based Wen Wei Po newspaper reported today that a deputy head of China's parliament said his nation should cut holdings of U.S. debt. China is able to stop buying dollar- denominated bonds and should instead increase imports from the U.S., the newspaper reported, citing Cheng Siwei, vice chairman of the Standing Committee of the National People's Congress.

China held $262.6 billion of U.S. Treasuries as of Jan. 2, according to Treasury data.

To contact the reporters on this story: Deborah Finestone in New York at dfinestone@bloomberg.net; Joshua Krongold in New York at jkrongold2@bloomberg.net.

Last Updated: April 4, 2006 17:08 EDT