Dollar holds near four-year highs, Europe stocks recover

By Emelia Sithole-Matarise

LONDON (Reuters) - The dollar held just below a four-year high against a basket of currencies on Friday, fuelled by the biggest yield advantage over the euro in nearly 15 years as the Federal Reserve contemplates hiking interest rates.

European equities shrugged off a sharp sell-off in Asian and U.S. markets overnight, clawing off one-month lows and led by euro zone banks, seen as the big winners of the European Central Bank's measures to prop up inflation and kick-start growth.

U.S. stock index futures pointed to a slightly firmer start on Wall Street after Thursday's sharp selloff triggered by Apple Inc and the rallying dollar.

The dollar index, which tracks the greenback against a basket of major currencies, edged up to 85.278, not far from a four-year high of 85.485 hit on Thursday.

The dollar is on track for its 11th successive weekly rise, something it has not achieved in four decades.

"It's Friday and so we may see some consolidation, but in general the dollar has broken through a number of long-term levels, so there's scope for us to go further before we meet much resistance," said Neil Mellor, a strategist with Bank of New York Mellon in London.

"Against the euro we have a forecast in the low $1.20s for a year's time, but the way things are going we could get there fairly quickly."

The dollar has been driven higher by the divergent monetary policy outlooks between a rate-hike-contemplating Fed and an ECB and Bank of Japan that are mulling further stimulus.

The yield difference between 10-year U.S. Treasuries and German Bunds reached its widest in nearly 15 years on Thursday, keeping pressure on the euro.

High bond yields tend to attract more fund inflows as bond investments account for a big chunk of international capital flows.

The euro was steady on the day at $1.2746, after falling as low as $1.26955 on trading platform EBS on Thursday, its lowest since November 2012.

ECB HOPES

European stocks were initially caught in Wall Street and Asia's downdraft but quickly recovered as banking stocks extended gains.

The FTSEurofirst 300 index of top European shares rose 0.3 percent at 1,376.61 points, retreating from its lowest level in almost a month hit the previous day.

Investors increasingly expect the region's banking stocks to rally in the next few months as the ECB steps up its efforts to support the currency bloc's anaemic growth.

Societe General equity analysts recommend buying European banks, as the central bank's asset quality review next month is set to bring more visibility on the sector.

"It's a theme that many clients want to play, but not necessarily directly with long positions on the cash market. There's been a big rise in the open interest in calls on banking stocks in the past few months," said Vincent Cassot, head of equity derivatives strategy at Societe Generale.

Brent crude nudged up to $97 a barrel but was still headed for its biggest monthly drop since April 2013 as rising supplies outweighed fears that U.S.-led strikes against Islamist militants in Syria and Iraq will disrupt oil production.

Slowing economic activity in Europe and Asia has dampened demand for oil, while supply is rising.

Spot gold added about 0.3 percent to $1,226.40 an ounce, after rebounding off Thursday's session low of $1,206.85 an ounce, which was its weakest level since Jan. 2. It looked set to snap a three-week losing streak, though dollar strength kept it in danger of breaking below $1,200 an ounce.

(Additional reporting by Patrick Graham and Blaise Robinson in Paris; Editing by Catherine Evans)