Market LookBeck II

(Reuters) - The dollar rose against a swath of currencies on Friday, rocketing to 4-1/2-year high against Japan's yen as data showing a robust rebound in U.S. consumer sentiment prompted investors to pile on bullish bets.

Debate over whether the Federal Reserve would wind down its asset buying program later this year gathered pace, helping push the dollar upward against a basket of currencies to a near three-year peak.

The greenback broke through the 103-yen mark after a report showed U.S. consumer sentiment in early May rose to the highest in nearly six years as Americans felt more confident about their financial and economic prospects.

The dollar was also buoyed by a rise in U.S. Treasury yields, which more inversely to price, although yields were rangebound.

"The consumer sentiment report fed into the story of the U.S. (economy) outperforming other countries," said Sebastien Galy, FX strategist at Soci?t? G?n?rale in New York.

"Markets want to be long the dollar and there is a snowball effect going on," he said. "Markets are also desperate for trends and once they identify one they forge ahead, forcing people to build up dollar positions, particularly as a cross asset hedge."

The dollar rose as high as 103.12 yen and last traded at 102.98 yen, up 0.7 percent on the day. Investors took Japan's Prime Minister Shinzo Abe's latest growth strategy in stride.

The dollar index, which measures its value against a basket of six major currencies, rose to 84.371 - its highest in nearly three years. It last traded at 84.224, up 0.8 percent on the day.

"It is a pure dollar story right now and with many investors underhedged in emerging markets, they are covering those positions," Galy said.

EURO WEIGHED ECB EXPECTATIONS

The euro, meanwhile, fell to a six-week low against the dollar, weighed by talk that the European Central Bank was checking banks' preparedness to handle a potential cut in its deposit rates.

"People are positive about the U.S. economic recovery despite recent weak data and today's theme is mostly about the broadly strong dollar," said Charles St-Arnaud, FX strategist at Nomura Securities.

"Meanwhile, data in the euro zone shows they remain in a recession and raised expectations the ECB will take further action is weighing on the euro," he said.

The euro fell as low as $1.2795, its lowest since April 4. It last traded at $1.2818, down 0.5 percent on the day.

Against the yen, the euro was at 131.98, up 0.2 percent.

"The negative deposit rate talk is a threat that the ECB is using to keep the euro lower," said Ian Gunner, portfolio manager at Altana Hard Currency Fund. "I doubt with the Bundesbank on board, the ECB will implement it."

Lowering the deposit rate to negative would make holding euros unattractive and lead to a broad sell off, traders say.

ECB board members Joerg Asmussen and Benoit Coeure said that monetary policy will remain accommodative, bolstering a view the central bank could use unconventional measures like introducing negative deposit rates in coming months to support the recession-hit economy.

Investors added to favorable bets on the dollar, drawing support from comments by a regional Federal Reserve chief who said the Fed could begin easing up on stimulus this summer.

San Francisco Fed President John Williams said the U.S. central bank could completely exit its easing by the end of the year.

Although Williams is not a voter this year at the Federal Open Market Committee, his views carry weight as they are often considered close to those of top Fed officials such as Chairman Ben Bernanke and Vice Chair Janet Yellen.

Bernanke and Yellen want to keep monetary policy ultra-loose for a longer period of time, while other policymakers, such as Richmond Fed chief Jeffrey Lacker say the economy's prospects are improving and the pace of asset purchases can be reduced.

"His comments took the market by surprise since he is a dove," said Peter Kinsella, currency strategist at Commerzbank.

"It is a dollar story this year as the U.S. labor and housing markets appear to be recovering. And while we do expect the Fed to be cautious in withdrawing stimulus, the economic recovery should drive the dollar higher," he said.