May 19 (Bloomberg) -- The dollar rose from its lowest in almost a week against the euro on speculation the Federal Reserve will keep raising interest rates while the European Central Bank makes no change.

The dollar is up 6.6 percent this year as the Fed, which raised rates eight times since June, indicates it will continue to lift borrowing costs. The dollar's decline yesterday, the most in two weeks, is an opportunity for traders to buy the currency, said Michael Klawitter, a currency strategist at WestLB AG.

``Dollar sentiment remains fairly upbeat,'' said Klawitter, who is based in Dusseldorf. ``Given the signs U.S. economic growth is clearly outpacing Europe, the interest-rate gap between the two remains a key driver for the market.''

Against the euro, the dollar strengthened to $1.2645 by 10:45 a.m. in London, from $1.2679 late yesterday in New York, when it fell by almost three quarters of a cent. The dollar rose to 107.21 yen from 106.99, according to foreign-exchange trading system EBS.

The dollar fell yesterday after a government report showed a U.S. gauge of inflation unexpectedly was unchanged in April. The median forecast of economists surveyed by Bloomberg was for an increase.

Fed policy makers two weeks ago increased the interest-rate target for overnight loans between banks to 3 percent, the eighth increase since June, and maintained a pledge to keep raising rates at a ``measured'' pace. The ECB has left its main rate at 2 percent since June 2003 and the Bank of Japan has kept borrowing costs near zero for more than four years.

Money Leaving Japan

The yen declined after a government report showed foreign investors sold Japanese stocks for the fourth week in five and Japanese bought the most overseas assets this year.

Overseas investors sold 36.5 billion yen ($341.2 million) of stocks in the week ended May 14, the Ministry of Finance said. Japanese investors bought 1.63 trillion yen in overseas securities, the most this year, the report said. It was the fifth straight week that more money left Japan than came in.

``Net portfolio outflows are not good for the yen,'' said Naomi Fink, a currency strategist in Tokyo at BNP Paribas SA. ``We're continuing to see foreigners selling Japanese stocks.''

Japan's currency may fall to 108 per dollar in the next week, she said.

Gains in the dollar may be limited on speculation a Fed report today will show manufacturing in the Philadelphia region weakened in May. The manufacturing index will fall to 17.3 from 25.3 last month, based on the median estimate of 58 economists surveyed by Bloomberg News.

``A weak Philly Fed report would be dire for the dollar,'' said Richard Yetsenga, a currency strategist in Hong Kong at HSBC Holdings Plc. ``Any case for the Fed being more aggressive would be done, and it could raise the possibility of the Fed pausing.''

China Speculation

Any decline in the yen may be limited after the Hong Kong Monetary Authority set a ceiling for its currency, spurring speculation the city is preparing for China to let the yuan trade more freely. The yen has tended to rise or fall as speculation about China's currency policy increases or wanes.

Hong Kong will prevent the currency from appreciating to curb purchases of securities by speculators betting China will allow the yuan to strengthen, the central bank said yesterday.

Hiroshi Watanabe, Japan's vice finance minister for international affairs said yesterday China ``has started and is already making good preparation'' to loosen the yuan's peg, speaking in an interview in St. Gallen, Switzerland.

The correlation between the yen and Chinese yuan 12-month non-deliverable forward contracts is 0.83. A figure of 1 means they move in lock step.

To contact the reporter on this story: Rodrigo Davies in London at rdavies13@bloomberg.net

Last Updated: May 19, 2005 05:47 EDT