European shares hit one-month high, dollar firms on Yellen's hike hint

By Anirban Nag

LONDON (Reuters) - European shares hit one-month highs on Monday, while the dollar index rose to a two-month peak after Federal Reserve Chair Janet Yellen suggested that an interest rate hike in the United States may be around the corner.

The Fed should raise rates "in the coming months" if growth picks up and the labour market continues to improve, Yellen said on Friday. St. Louis Fed President James Bullard chimed in, saying on Monday, global markets appear to be "well-prepared" for a summer rate hike, although he did not specify a date for the policy move.

The probability of a rate increase at the Federal Open Market Committee's June 14-15 meeting rose to around 34 percent from 26 percent on Thursday, according to CME's Fedwatch programme. Bets on an increase at the July 26-27 policy meeting edged up to 60 percent, more than double the level of a month ago.

Against a basket of currencies, the dollar was up 0.4 percent at 95.879, while the euro struggled near 2-1/2 month lows of $1.1097 hit in the Asian session.

The euro zone's blue-chip Euro STOXX 50 index was 0.1 percent higher, while Germany's DAX was up 0.3 percent, hitting a one-month high. Trading volumes are expected to be thin as the London and New York markets are closed for a public holiday.

While higher U.S. interest rates would sap global liquidity, Wall Street and European investors took Yellen's comments in their stride, as they suggested the world's largest economy was strong enough to weather another rate hike, following from the December hike.

"The return to U.S. rate hike expectations have reopened the possibility of short-term outperformance for European stocks," said Didier Duret, global chief investment officer at ABN-AMRO Private Banking, adding investors were keeping an eye on the dollar for it to break recent ranges.

The rise in European markets came after Japan's Nikkei stock index ended up 1.4 percent, as the yen weakened to a one-month low and expectations rose that the government would delay a sales tax hike scheduled for April next year.

Japanese Prime Minister Shinzo Abe said he would delay the increase by 2-1/2 years, Masahiko Komura, vice president of the ruling Liberal Democratic Party, told reporters on Monday, echoing what a government source told Reuters on Sunday.

One uncertainty, however, is how markets would react if a postponement of Japan's sales tax hike were to lead to a downgrade of the country's sovereign rating.

"What would be scary is if there were to be a downgrade. I think equities would fall if that happens. That remains a risk," said Satoshi Okagawa, senior global markets analyst for Sumitomo Mitsui Banking Corporation in Singapore.

EYES ON US DATA

This week investors will keep an eye on the all-important U.S. non-farm payrolls and the Institute for Supply Management surveys. The May jobs report is due on Friday and a solid reading could heighten expectations for a June move.

Economists expect U.S. employers to have added 170,000 jobs this month, slightly more than they did in April. Hourly wages are expected to show a 0.2 percent increase from the previous month.

Crude oil futures remained shy of the $50 per barrel level after marking weekly gains, feeling some pressure from the stronger U.S. dollar that made it more expensive for holders of other currencies.

Brent crude slipped to $49.10 a barrel, after gaining 1 percent last week. U.S. crude was down 0.3 percent at $49.18 after rising about 3 percent for the week.

The dollar's strength took a toll on spot gold, which dropped 0.9 percent to $1,201 an ounce. It plumbed a low of $1,199.60 earlier in the day, its lowest since late February.

(Additional reporting by Atul Prakash and Lisa Twaronite; Editing by Hugh Lawson)