TIGHT FEDERAL RESERVE POLICY MAY SPARK MODEST DOLLAR RALLY

TIGHT FEDERAL RESERVE POLICY MAY SPARK MODEST DOLLAR RALLY

The U.S. dollar will rise because the Federal Reserve will maintain a tight monetary policy, foreign exchange traders said.

However, the West German central bank also has indicated it will act to protect the soundness of the deutsche mark, so any rally by the dollar may be limited, they added."Fear of Bundesbank intervention is well-grounded," said Bill Jansen, currency trader at Discount Corp. of New York.

Mr. Jansen said the West German central bank has gone on record clearly indicating its readiness to keep the country's currency strong ahead of the July 2 implementation of monetary union with East Germany.

The dollar rose to just above 1.70 deutsche marks Friday before slipping back a bit from that peak in afternoon trading. Many traders believe the Bundesbank will intervene this week to buy deutsche marks and sell dollars if the U.S. currency attempts to push ahead to the DM1.72 level.

Ian Spence, chief foreign exchange dealer at Manufacturers Hanover Trust Co., noted that a lot of important U.S. economic reports will be released later this week, ending a dearth of data that has dampened trading enthusiasm.

Key reports on tap for May will include retail sales on Wednesday, the producer price index on Thursday, and the consumer price index, industrial production and capacity utilization on Friday. The April U.S. merchandise trade statistics also will be released on Friday.

Unless new data indicate a distinct weakening in the economy, the Fed seems likely to avoid any policy moves to encourage lower interest rates, traders said.

"I don't think there will be much of a slowdown" in the U.S. economy, Mr. Spence said. "Interest rates will remain firm until there is an agreement to reduce the budget deficit. And if there is a budget agreement, that would be good for the dollar," he added.

Comments last week by a number of Fed governors and by Fed Chairman Alan Greenspan indicated that they believe the economic data have been too ambiguous to prompt any easing of monetary policy, traders said.

U.S. interest rates likely will remain high, therefore, and provide good support for the dollar, they added.

Recent weakness in precious metals, with gold falling to near a four-year low last week, also could be a positive sign for the dollar, said Mr. Jansen of Discount Corp.

"Weak gold prices have been a good corollary to a strong dollar," he noted.

The U.S. currency also may benefit from "safe haven" appeal, Mr. Jansen said.

"The political uncertainties in Germany will work themselves out," he added, "but it is not at all clear what the outcome or the effects will be of continued unrest in the Soviet Union."

Francoise Soares-Kemp, vice president-treasury and head corporate foreign exchange trader at Credit Suisse in New York, said, "The continuing disintegration in the Soviet Union gives the dollar a boost, and it looks as if it will be a long hot summer there."

The United States is still regarded as "the only place to be when in doubt," she said. "When in doubt, buy dollars."

Although the Japanese yen has recovered from its lows of earlier this year, ''the Japanese situation is still fragile," Ms. Soares-Kemp said.

"One of Japan's goals is supposed to be asset deflation, and they're going in the opposite direction," she said.