April 5 (Bloomberg) -- The dollar advanced against the euro after Federal Reserve Chairman Ben S. Bernanke said inflation must be watched "extremely closely," encouraging bets that interest rates may be raised sooner than previously expected. The U.S. currency appreciated versus most of its major counterparts as Bernanke said yesterday in Stone Mountain, Georgia, that policy makers would "have to respond" if estimates that faster inflation will be transitory prove incorrect. The euro fell after Moody's Investors Service lowered Portugal's long-term credit rating by one step to Baa1. "Bernanke's comments suggest that the market might be underestimating the degree to which the Fed could tighten monetary policy, and that sets the scene for a narrow dollar rally," said Lee Hardman, a currency strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. in London. "Europe's debt crisis is far from being resolved, and that's another reason that could push euro-dollar lower." The dollar appreciated 0.3 percent to $1.4176 at 8:55 a.m. in New York, from $1.4221 yesterday. The yen declined 0.3 percent to 84.33 versus the dollar, from 84.06. The euro was little changed at 119.54 yen, compared with 119.54. Bernanke's comments yesterday echoed his March 1 statement to lawmakers that Fed officials were "prepared to respond as necessary" to inflationary pressures. The policy-setting Federal Open Market Committee, led by Bernanke, said following its March 15 meeting that it "will pay close attention" to the evolution of inflation and inflation expectations. The central bank will release minutes of the meeting today. Fed's 'Subtle Change' "The dollar is doing well on the back of rate-hike expectations," said Chris Walker, a currency strategist at UBS AG in London. "Bernanke's comments indicate a subtle change in the Fed's rhetoric towards a slightly less-dovish stance, although the market might be overreacting to it a bit." The Fed has kept its benchmark interest rate at zero to 0.25 percent since December 2008 and reiterated last month that it would remain there for an "extended period." The yen weakened against the dollar as people familiar with the matter said the Bank of Japan is considering offering temporary loans to banks to aid companies with cash-flow shortages following the March 11 earthquake. The plan may be presented to the BOJ board as early as this month, the people said, speaking on condition of anonymity because the discussions weren't public. Outlook for BOJ The central bank will keep its target rate at zero to 0.1 percent on April 7, according to the median forecast of 14 economists in a Bloomberg News survey. "The Fed will be catching up with the ECB in raising interest rates, while the BOJ is heading in the opposite direction," said Daisuke Karakama, a market economist in Tokyo at Mizuho Corporate Bank Ltd., Japan's second-largest publicly traded lender. "I don't see any reason to buy the yen." The European Central Bank will increase its main refinancing rate by a quarter-percentage point from a record low 1 percent at its April 7 meeting, according to all of the 57 economists in a Bloomberg News survey. China raised borrowing costs for the fourth time since the global financial crisis to limit the risk of asset price bubbles in the world's fastest-growing major economy. The benchmark one- year lending rate will increase to 6.31 percent from 6.06 percent effective tomorrow, the People's Bank of China said on its website today. The one-year deposit rate will rise to 3.25 percent from 3 percent. Dollar Index Intercontinental Exchange Inc.'s Dollar Index, which tracks the greenback against the currencies of six major U.S. trading partners, rose for a second day, increasing 0.1 percent. The U.S. Institute for Supply Management's index of non- manufacturing businesses fell to 59.5 in March from 59.7 in the previous month, which was the highest since August 2005, according to the median forecast of 68 economists. A reading above 50 indicates growth. The pound advanced 0.9 percent to 87.33 pence per euro and gained 0.7 percent to $1.6240 after a report showed service industries grew in March more than economists forecast. Markit Economics Ltd. and the Chartered Institute of Purchasing and Supply said a gauge of U.K. services based on a survey of companies rose to 57.1, the highest level in 13 months and above the median forecast of 52.6. The Swiss franc gained 0.3 percent to 1.3085 versus the euro after Moody's second downgrade of Portugal in three weeks boosted demand for assets perceived as less risky. The cut in Portugal's rating was driven by "increased political, budgetary and economic uncertainty," the ratings company said today. "The whole safe-haven argument is always a factor for the franc," said Paul Bednarczyk, a strategist at 4Cast Ltd. in London. "The latest Portugal downgrade is another weight on the euro."

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