Dollar up sharply on Fed chief's tough talk

The dollar rose to the biggest two-day gain versus the euro since 2005 after Federal Reserve Chairman Ben Bernanke said economic risks have faded, spurring traders to boost wagers that interest rates will climb.

The U.S. currency rose Tuesday to a three-month high against the yen after Bernanke said late Monday the central bank will "strongly resist" any waning of public confidence in stable prices.

"Strong" economic fundamentals will translate to dollar strength, Treasury Secretary Henry Paulson said Tuesday.

Policymakers are trying to "dispel this notion in the market that the U.S. has a policy of benign neglect to the dollar," said Sophia Drossos, a currency strategist in New York at Morgan Stanley. "They are making it very clear that the benefits of a weak dollar are far outweighed by the costs."

The dollar climbed 1.2 percent to $1.5449 per euro Tuesday from $1.5646 Monday, bringing the two-day gain to 2.02 percent, the most since Nov. 4, 2005. The dollar rose to 107.42 yen, the highest since Feb. 27, from 106.10 Monday.

Futures on the Chicago Board of Trade show a 52 percent chance the Fed will raise its 2 percent target rate for overnight lending between banks by at least a quarter point at its Aug. 5 meeting, compared with 31 percent the previous day.

The contracts show a 96 percent chance the Fed will increase the rate by December, up from 67 percent a week ago.

The dollar has fallen 11.5 percent against the euro and 7.2 percent versus the yen since September, when the Fed began to lower borrowing costs from 5.25 percent.

Crude oil Tuesday climbed to $137.98 a barrel in New York before falling more than $3 to settle at $131.31 on the New York Mercantile Exchange. The price has more than doubled in the past year.

"The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so," Bernanke said in a speech at a Boston Fed conference.

"The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations."

Paulson said the administration intends to keep pursuing a policy of "robust engagement" with China that will include pressuring the Chinese to move more quickly to revalue their currency.

Paulson, delivering a speech Tuesday outlining the goals of a high-level meeting the two countries will hold next week, also said it was important for both nations to resist calls for erecting protectionist barriers.

The yuan traded near the highest level since a dollar peg was scrapped in 2005. The currency was little changed at 6.9255 per dollar in Shanghai, compared with 6.9230 June 6, according to the China Foreign Exchange Trade System.

"You are going to see the dollar rally quite strongly over the next 12 months," said Michael Aronstein, chief investment strategist at Oscar Gruss & Son.

"Global investors are quite underweight [on the dollar]. You could see the beginning of a real reversal of that."

Material from The Associated Press was used in this report.