Dollar builds on rally as Fed prepares ground for December lift off

By Anirban Nag

LONDON (Reuters) - The dollar hit a three-month high against a basket of major currencies on Thursday, bolstered by comments from influential Federal Reserve officials who kept chances of an interest rate hike in December alive.

U.S. two-year Treasury yields rose to their highest in 4-1/2 years and spreads over their German counterparts widened to their maximum since late 2006, boosting the dollar's allure for investors.

The dollar index <.DXY>, which tracks the greenback against six major peers, rose 0.1 percent to 98.135 in the European trading session, after having gained 0.8 percent on Wednesday.

The dollar's gains came as chances for a December rate hike rose over 50 percent after Federal Reserve Chair Janet Yellen laid out what appears to be the base case at the U.S. central bank that the economy is ready for higher interest rates.

Driving home the point, William Dudley, the influential president of the New York Fed and a permanent voter on policy, later said the he would "completely agree" with Yellen that December is a "live possibility" for raising rates.

"There is a strong momentum for the dollar as rate hike chances for December have improved," said Yujiro Goto, currency strategist at Nomura. "A lot depends on how the U.S. jobs data pans out, but data of late has been encouraging."

Economists expect the U.S. nonfarm payrolls report on Friday to show that employers added 180,000 jobs last month . A number above 165,000-170,00 along with a tick up in wages would prompt the Fed to start hiking rates in December, Goto said.

The greenback broke out of its recent 120.00-121.60 range against the yen , to reach a two-month high of 121.99 yen.

With the European Central Bank promising to go the other way -- providing more policy stimulus -- the euro fell to its lowest in over three months at $1.0834 . It recovered slightly to trade at $1.0880, flat on the day, with ECB President Mario Draghi reiterating that a decision whether more stimulus was needed or not would be taken at its next meeting.

Some analysts warned dollar bulls not to get too carried away in the lead-up to the jobs data, leading to some caution.

Sterling fell sharply, retreating from a 11-week high against the euro , and 0.7 percent against the dollar after Bank of England dampened expectations of an interest rate hike in the near term. In its Inflation Report, it predicted near-zero inflation would pick up only slowly even if borrowing costs stay on hold all of next year. [GBP/]

And the minutes showed only one BoE policymaker, Ian McCafferty, voted to raise rates this month, while the other eight members opted to keep them at a record-low 0.5 percent. Some in the market were expecting at least one more member to join McCafferty in voting for rate hikes.

"The BoE was very dovish compared with expectations that were building up," said John Hardy, currency strategist at Saxo Bank. "We could see sterling drop further against the dollar if we get a good U.S. jobs number."

(Editing by Catherine Evans)

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