FOREX-Dollar rally pauses; investors jittery over energy price surge

By Amanda Cooper

LONDON, March 4 (Reuters) - The dollar held firm near three-month highs on Wednesday, with investors turning deeply bearish towards the euro as the conflict in the Middle East sparked fears of a sustained rise in energy prices and took a heavy toll on stock markets.

The euro EUR= edged up 0.2% to $1.16135, having earlier hit its weakest level since late November. That followed data released on Tuesday that showed euro zone inflation accelerated more quickly than expected in February, before the start of the Iran conflict.

A report in the New York Times on Wednesday that cited officials briefed on the matter saying Iran's Ministry of Intelligence signalled to the U.S. Central Intelligence Agency openness to talks on ending the war injected a small note of optimism among investors that dragged on the dollar.

"Everyone is a bit nervy and a bit jittery and, understandably wanting to pounce, or overreact to any signs of optimism... however tentative," Pepperstone senior research strategist Michael Brown said.

OPTIONS MARKET SIGNALS EURO WEAKNESS

The options market shows traders are at their most bearish towards the euro in at least a year, having flipped from an overwhelmingly bullish position just six weeks ago.

"We're still in a scenario where dollar selloffs are probably going to be short-lived and probably bought into because there is still a lot of negativity priced into most currencies, which are sensitive to energy prices," CIBC Capital Markets head of G10 FX strategy Jeremy Stretch said.

"And here in Europe, it's all about the natural gas prices," he said. "If there comes to be more of a supply, as well as a price, issue, then obviously that becomes much more problematic for the euro zone."

The cost of buying options to sell the euro against the dollar over the next three months against the cost of options to buy it is at its largest premium since last March, according to LSEG data, indicating a belief among traders that the euro has further to fall. EUR3MRR=

Deutsche Bank global head of FX research George Saravelos said in a note on Tuesday that, roughly, for every combined 10% rise in Brent and European natural gas prices, the euro loses around 0.8% in value.

"This means that a combined move to $100/barrel in both Brent and (natural gas futures) would take euro/dollar down to roughly $1.13 on current sensitivities," he said in his note.

Global oil and gas prices have jumped as the strikes on Iran disrupt energy exports from the Middle East, with Tehran's attacks on ships and energy facilities in response closing navigation in the Gulf and forcing production stoppages from Qatar to Iraq.

Elsewhere, the pound GBP= rose 0.1% to $1.337. Sterling has been hit hard by the prospect of a protracted rise in energy prices given that British inflation, at 3%, is still well above the Bank of England's 2% target.

The dollar index =USD, which tracks the U.S. currency's performance against six others, dipped 0.2% to 98.86, having earlier reached its strongest level since November 28.

Against the yen JPY=, the dollar was down 0.37% at 157.2 yen.

The U.S. currency also fell 0.3% versus the Chinese yuan CNH= to 6.899 in offshore trade, after PMI data for February diverged, with official gauges recording a slump in activity even as a private-sector counterpart blew past estimates.