The US dollar strengthened against both the euro and sterling today after America's central bank signalled the possibility of raising interest rates to stem inflation and President Bush said he believed market forces would help the greenback recover.

Ben Bernanke, chairman of the US Federal Reserve warned in a speech in Massacheusetts on Monday evening that the central bank would "strongly resist an erosion of long term inflation expectations", raising hopes that the cost of borrowing may rise above the current 2 per cent level by the end of the year.

In early trading today, the euro fell to $1.5496 against the dollar while the pound weakened to $1.9570.

In turn, gold - a typical hedge investment for a weakening dollar - slipped by more than 2 per cent to $874.05 an ounce.

The greenback was also boosted by comments made by President Bush and his Treasury Secretary Henry Paulson.

Speaking at an EU-US summit in Slovenia earlier today, the US President reiterated remarks made to The Times in an exclusive interview this week, indicating that he believed market forces would eventually help the dollar to strengthen.

Mr Paulson also indicated that he had not ruled out intervening in world currency markets to prop up the US dollar.

A move to intervene in the foreign exchange markets would require the US Treasury and Federal Reserve using their own funds to acquire dollars to prop up the American currency and would mark the first measure of its kind since the Clinton administration.

However, new statistics calculating the size of America's trade deficit published today, will also increase pressure on the Fed to raise interest rates.

The official data showed the extent of the damage that surging oil prices had incurred on the US economy, by pushing up import inflation.

In April, the US trade deficit - which measures the difference between the value of imports into the US and exports out of the country - rose to $60.9 billion, almost $1 billion above Wall Street expectations.

That rise represents a 7.9 per cent increase compared with the US March deficit. Last week, fears of a conflict between Israel and Iran saw the price of light sweet crude rise by $11 to almost $138 a barrel, representing a new record. Morgan Stanley, the US investment bank, told its clients to expect oil to rise to $150 within a month.

Carl Weinberg, of High Frequency Economics, explained that the widening trade deficit would apply further pressure on the US dollar and would erode economic growth.

He said: "But I would be flabbergasted beyond belief if the US intervenes in the currency markets, primarily because history has told us that it doesn't work. The Japanese spent $100 billion [trying to prop up the yen] and it didn't work. The force of capital markets far outweigh what a central bank can do to prop up a currency."

Dimitry Fleming, US economist for ING Bank, said: "Financial markets, currently seized by inflation fears, are likely to push aside

today's [trade deficit] report and swiftly move on to the May import price report, due next Thursday. With oil prices around record high levels, pushing up import inflation, that report is destined to feed fears for Fed rate hikes later this year."

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