The euro erased losses against the dollar Monday as expectations that the European Central Bank will tighten monetary policy as early as next month softened concerns about Germany’s ruling party losing a key state election. ECB President Jean-Claude Trichet on Monday said inflation rates are durably above its price stability target The euroerased losses after Trichet’s comments and was last trading flat on the day at $1.4074 after sliding as much as 0.3 percent lower on the back of concerns about Chancellor Angela Merkel’s loss. The euro, nevertheless, is off a 4-1/2 month high of $1.4249 hit last week on EBS. While the loss by Merkel’s conservatives of Baden-Wuertemberg, which they had held for nearly six decades, led markets to bet Merkel will have less leeway to shore up financially stricken members of the single currency bloc, expectations of a euro-zone interest rate rise continue to offset worries about heavily indebted Portugal and Spain. “The effect should be seen in less freedom for the German government to take unpopular political stands, such as in nuclear power and economic assistance to periphery countries,” Brown Brothers Harriman said in a note.“This does not bode well for the periphery, in light of near term issues with Ireland and Portugal.” Irish bank stress tests are to be released Thursday and forecasts have 20 billion euros as the additional capital required. Near-term euro support lies at the 20-day moving average near $1.40, and trendline support around $1.3975, which is drawn through the euro’s Jan. 10 low of $1.2860 and March 11 low of $1.3752. While the euro should stay under pressure in the short run on concern about a worsening debt crisis in Portugal following the collapse of the country’s government, the euro should be supported as long as it holds above $1.40. Expectations of a euro-zone interest rate rise as early as next month have mostly offset worries about heavily indebted Portugal and Spain. The U.S. dollar indexwas flat at 76.202, bouncing from a recent 15-month low. Monetary policy should remain a key driver for the dollar, with Friday’s reaction to Philadelphia Fed President Plosser’s speech highlighting how sensitive the greenback has become to any potential shift in the stance at the Fed. Plosser said the Fed needs to lean against inflation. “A shift to a more hawkish stance at the Fed, is an important risk to our USD bear view,” said Camilla Sutton, chief currency strategist at Scotia Capital in Toronto. ”However, we continue to believe that the Fed will remain on hold for many quarters to come and prove one of the last central bank to finally tighten policy.” This, in the medium term, should prove a weight against the dollar, she said. U.S. consumer spending rose slightly more than expected in February for the eighth straight month of gains as households tapped their savings, U.S. Commerce Department data showed on Monday, while inflation accelerated at its fastest pace since June 2009. The dollar was up 0.4 percent at 81.67 yen with implied volatilities staying low, which traders said was ruling out the need for any further official yen selling intervention in the near-term. One-month dollar/yen vol traded around 10 percent compared with around 20 percent when the yen rose to a record high of 76.25 earlier this month.

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