Dec. 21 — The dollar headed for a second weekly gain against the euro before a U.S. government report that economists said will show the Federal Reserve’s preferred inflation gauge accelerated last month.

The U.S. currency traded near a six-week high versus the yen and was poised for the biggest weekly advance against the British pound in a month, on speculation rising consumer prices will discourage the Fed from cutting borrowing costs even as economic growth slows. The yuan rose to the highest since a dollar link was scrapped in 2005 after China raised interest rates yesterday for a sixth time this year.

“It may be easy to buy the dollar against European currencies,” said Tsutomu Soma, a bond and currency dealer at Okasan Securities Co. in Tokyo, Japan’s sixth-largest brokerage. “Inflationary pressure means the Fed doesn’t have much leeway to lower rates. The same can’t be said about European central banks.”

The dollar was at $1.4360 per euro at 2:10 p.m. in Tokyo after yesterday reaching $1.4311, the strongest since Oct. 25. The U.S. currency traded at $1.9874 to the pound and was little changed at 113.05 versus the yen. The dollar may rise to 113.40 against the Japanese currency today, Soma said.

Currency moves may be exaggerated as many traders have taken time off for the year-end holidays, said Masanobu Ishikawa, general manager of foreign exchange at Tokyo Forex & Ueda Harlow Ltd., Japan’s largest currency broker.

Hedge Fund Positions

The U.S. currency rose the most this week versus the South African rand and pound, breaking beyond $2 to the U.K. currency for the first time since September. The dollar gained 1.3 percent to 6.9763 rand and 1.5 percent to the pound. The U.S. Dollar Index traded on ICE Futures in New York reached 77.854 yesterday, the highest since Oct. 23 and was at 77.628 today.

The difference in the number of wagers by hedge funds and other large speculators on a drop in the dollar versus the euro compared with those on a gain — so-called net shorts — fell to 63,374 in the week ended Dec. 11, from 69,117 the previous week, figures from the Washington-based Commodity Futures Trading Commission show. The five-year average is 35,488.

“The dollar is likely to remain well supported for the rest of the year,” said Masahiro Sato, joint general manager of the treasury division in Tokyo at Mizuho Trust & Banking Co., a unit of Japan’s second-largest publicly traded lender. “U.S. investors are closing out positions and repatriating funds to meet their financing needs.”

The U.S. currency may rise to $1.42 against the euro and 113.50 yen today, he said.

U.S. Inflation

The dollar has rebounded from a record low of $1.4967 per euro touched last month, paring an annual loss to 8.1 percent. The dollar has advanced against all 16 of the most-actively traded currencies this month except Canada’s dollar and Mexico’s peso.

The U.S. Commerce Department’s index of core consumer prices that excludes food and energy, the Fed’s preferred inflation measure, rose 2 percent in the year through November, the fastest since May, according to the median forecast of economists surveyed by Bloomberg News. The report is due at 8:30 a.m. in Washington.

A technical indicator some traders use to predict currency movements suggests gains in the dollar may stall. The euro’s 14- day relative strength index was 34.5 yesterday, approaching the level of 30 that signals the U.S. currency’s advance may have been excessive. The pound’s RSI reached 30.9.

Japan Outflows

The yen weakened versus all the 16 most-traded currencies today as speculation the Bank of Japan will refrain from raising interest rates at least until the second half of 2008 spurred fund managers to invest in higher-yielding assets abroad.

Japan’s currency snapped a two-day advance versus the euro as financial companies in Japan are marketing more than 300 billion yen ($2.6 billion) of funds aimed at overseas markets for today, according to data compiled by Bloomberg.

The Bank of Japan left the overnight lending rate at 0.5 percent yesterday. Economists are now predicting Governor Toshihiko Fukui may even have to cut the rate after the central bank lowered its assessment of the economy for the first time in three years.

“With the BOJ downgrading the economic assessment, it should actually be high time to discuss a rate cut,” said Ryohei Muramatsu, manager of Group Treasury Asia in Tokyo at Commerzbank AG, Germany’s second-largest bank. “Should market players start new investments through yen sales after the Christmas break, the dollar-yen may rise to 114.”

Carry Trades

The yen weakened to 162.35 per euro compared with 162.11 yesterday in New York. The currency has dropped against eight of the 16 most-traded currencies in 2007, including the Australian, New Zealand and Canadian dollars, favorites for so-called carry trades because of the interest-rate premiums on offer.

Borrowing costs are 8.25 percent in New Zealand, 6.75 percent in Australia and 5.25 percent in Canada. In carry trades, investors get funds in a country with low rates and buy higher- yielding assets elsewhere, earning the difference. The risk is that currency moves erode profits.

The U.S. currency has weakened this year as widening credit- market losses and the worst housing slump in 16 years caused the Fed to cut interest rates three times to prop up economic growth. Policy makers now face a dilemma with the economy slowing and inflation picking up.

The dollar declined 8 percent against the euro in 2007, less than last year’s 10.2 percent loss and against the pound the dollar weakened 1.4 percent versus a 12 percent tumble last year. The U.S. currency dropped 5 percent against the yen after rising 1.1 percent in 2006.

Interest-rate futures on the Chicago Board of Trade indicate 90 percent odds the Fed will reduce the benchmark rate a quarter- percentage point to 4 percent at its Jan. 30 meeting compared with 94 percent a month ago.