The rupee snapped a four-week losing trend, adding 2 percent on the week, on robust dollar inflows into domestic bonds and supported by gains in world stocks following six major central banks' move to cut funding costs for banks.
Traders said the rupee is expected to appreciate further next week as foreign funds are likely to invest more in bonds.
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The partially convertible rupee ended at 51.20/21 per dollar Friday, 0.5 percent higher than its 51.46/47 Thursday, when it had risen 1.4 percent - its biggest one-session rise since May 18, 2009.
"There are debt market inflows seen. In the near-term, the rupee could touch 51 per dollar, and thereafter if the positive sentiments continue, it could hit 50.70 levels," said Ashish Barua, a senior forex dealer with IndusInd Bank.
The auction of limits entitling foreign institutional investors to buy up to $5 billion each in government bonds and corporate debt received bids worth $14 billion Wednesday, four market sources had said.
Foreign funds will have to utilize the government bond limits within 45 days of the allotment, which is likely to boost demand for debt.
On Thursday, foreign funds bought Indian shares worth $175.17 million, and debt worth $277.87 million, compared with $26.80 million and $108.71 million in the previous session.
"Dollar inflows in the local market are likely to partially offset concerns in the near term over a widening current account deficit," said N.S. Venkatesh, treasurer at state-owned IDBI Bank.
Outlook on dollar inflows has brightened after the U.S. Federal Reserve, the European Central Bank and the central banks of Canada, Britain, Japan and Switzerland said in a joint statement they had agreed to lower the cost of existing dollar swap lines by 50 basis points from December 5.
The Reserve Bank of India's decision to ease rules on overseas borrowings by firms and raise ceiling on interest rates for deposits by non-resident Indians also aided.
The BSE Sensex shares posted solid gains for a third straight day on Friday and logged its best week since July 2009 on prospects of a revival in foreign fund inflows. Corporates' selling dollars earlier in the day also aided the rupee.
Traders will also watch the euro for direction ahead of a key EU summit on December 9, seen as yet another make-or-break meeting for the 12-year-old currency bloc.
The euro held on to recent gains on Friday, supported by expectations that U.S. jobs data would show the economy slowly recovering, but it struggled to extend its rally in the absence of a comprehensive solution to the euro zone debt crisis.
The non-farm payrolls report, expected to show an increase of 122,000 jobs and a steady unemployment rate of 9.0 percent, due at 1330 GMT, will also be watched.
The one-month offshore non-deliverable forward contracts were quoted at 51.53, indicating a bearish near-term outlook.
The one-month onshore forward dollar premium was at 28.50 points from 27.75 points, the three-month steady at 67.25 points, and the one-year premium was at 198.50 points from 186.50.
In the currency futures market, the most traded near-month dollar-rupee contracts on the National Stock Exchange, the United Stock Exchange and the MCX-SX were at 51.4200, 51.4225 and 51.4450 respectively. The total volume was at $3.5 billion.