June 30 (Bloomberg) -- The dollar headed for the biggest quarterly advance against the euro since 2001 amid speculation the Federal Reserve will today increase its benchmark interest rate and signal it will keep increasing borrowing costs.

The U.S. currency has rallied 7.4 percent this quarter, buoyed by a widening yield advantage with the euro region and faster economic growth than Europe for a fourth consecutive year. The dollar is also up 3.2 percent compared with the yen and has strengthened versus the Swiss franc and British pound.

``The Fed is going to keep raising the interest rate and that's top of our list for why the dollar will keep going higher,'' said Gregorios Siourounis, a currency strategist at Barclays Capital in London. ``The U.S. economy seems to be performing better than any other major economy.''

Against the euro, the dollar was at $1.2061 at 7:16 a.m. in New York, from $1.2070 late yesterday, according to electronic currency-dealing system EBS. The dollar gained to 110.68 yen from 110.43. Earlier today, it strengthened to 110.73 yen, an eight- month high. Among the most actively traded currencies, only Brazil's real and the Mexican peso rose compared with the dollar this quarter.

Fed policy makers will today lift their target rate for overnight loans between banks by a quarter point to 3.25 percent, according to the median estimate of economists surveyed by Bloomberg. The Fed will raise rates at least two additional times this year, according to the majority of the 22 primary dealers of U.S. government securities.

The European Central Bank has left its benchmark rate at 2 percent, the lowest for any of the dozen nations using the euro in at least six decades, since 2003. The Bank of Japan has kept borrowing costs near zero since 2001.

Bulls in Redtower

The dollar may advance to $1.13 next quarter, said Gerry Celaya, chief strategist at Redtower Research, a market forecasting company in Aberdeen, Scotland.

Redtower predicted that the dollar would advance to $1.22 against the euro by the end of this month, the most bullish prediction for the dollar this quarter in a Bloomberg survey published April 8.

``The dollar should be stronger with the U.S. economy holding up and looking at the eurozone we didn't see much growth there,'' said Celaya. ``The story is that the Fed is hiking rates.''

The dollar's advance this quarter was unexpected by most of the traders, strategists and investors surveyed by Bloomberg at the end of March and beginning of April. The median forecast was for the dollar to weaken to $1.32 per euro and 103 yen.

Record U.S. trade and fiscal deficits combined with the lowest interest rates in four decades sent the dollar down against the euro and yen for three consecutive years.

Yield Advantage

The spread between two-year U.S. Treasury notes and similar- maturity German government bonds was about 161 basis points, up 7 basis points from the start of the week. On June 21, the gap widened to 166 basis points, the most since 2000. A basis point is 0.01 percentage point.

``The U.S. interest-rate and growth differential story speaks for itself,'' said David Mozina, a currency strategist in Sydney at ABN Amro Holding NV. ``There's no reason for the Fed to stop tightening here. The dollar is still headed higher.''

Consumer confidence in France, Europe's third-largest economy, fell to a record this month and the jobless rate held at a 5 1/2-year high in May, government reports showed today.

Japanese Economy

The yen is heading for its second consecutive quarterly decline in part on signs a 63 percent increase in oil prices this year will restrain growth in Japan. Japanese industrial output dropped 2.3 percent in May as exports slowed, a report showed yesterday.

``In an environment of a stronger dollar, if the oil price moves up that leaves the yen vulnerable,'' said Gavin Friend, a currency strategist in London at Commerzbank AG. ``The market is expecting a slight pick up in the Tankan and if we get that the yen could recover.''

The Bank of Japan's Tankan index of confidence among large manufacturers probably rose to 16 points in June from 14 in March, based on the median forecast of 27 economists surveyed. A positive number means optimists outnumber pessimists.

Crude oil for August delivery was little changed at $57.43 a barrel, in after-hours electronic trading on the New York Mercantile Exchange. Yesterday, the August contract fell 1.6 percent, to 57.26 a barrel, and has declined 5.9 percent since it reached a record $60.95 three days ago.

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

Last Updated: June 30, 2005 07:26 EDT