By Samuel Indyk and Tom Westbrook
LONDON (Reuters) -The dollar was edging higher on Wednesday and headed for its biggest monthly gain since September and while the yen was set for its sharpest monthly drop in almost a year, as traders waited on a U.S. rates decision to round out January.
The has gained 2.1% against a basket of major currencies this month as markets dialled back expectations on the speed and scale of U.S. rate cuts in the face of strong economic data and pushback from central bankers.
On the day, the dollar index was up 0.1% to 103.51, just below Monday’s 103.82 which matched last week’s seven-week high.
A sharp slowdown in Australian inflation pushed the dollar down as much as 0.5% to $0.6560 and rallied bonds as investors pulled forward wagers on interest rate cuts, while a moderation in French inflation added to losses for the euro.
Elsewhere moves were more modest, and the yen made little immediate reaction to a hawkish tilt at the Bank of Japan, while markets waited to hear from the Federal Reserve.
The yen is down almost 4.5% on the dollar this month and headed for its largest monthly drop since February last year as tepid wage data and cooling inflation leave room for the Bank of Japan to take its time raising rates.
However, a summary of its January meeting on Wednesday showed its resolve strengthening and conditions supporting an end to negative rates relatively soon.
The Federal Reserve meanwhile is expected to hold U.S. interest rates steady on Wednesday but flag cuts are coming by dropping language indicating it is weighing further hikes.
Interest rate futures price a roughly 43% chance of a Fed rate cut in March, down from 73% at the start of the year.
“If we get a softer tone from (Federal Reserve Chair Jerome) Powell then I think there’s a risk that the dollar would weaken,” said Dane Cekov, senior macro and FX strategist at Nordea.
Ahead of the Fed, Cekov highlighted the U.S Treasury’s quarterly refunding announcement and the closely-watched employment cost index for evidence of wage growth in the fourth quarter as potentially key for the dollar outlook.
German inflation figures are due on Wednesday after French EU-harmonised inflation earlier moderated to 3.4% in January from 4.1% in December.
A slowdown in Germany would foreshadow the same in Eurozone numbers due on Thursday and reinforce market expectations that European policymakers could start rate cuts earlier than the ECB has signalled.
The euro was last down 0.2% at $1.0829, while sterling was down a similar amount to $1.2680 before the Bank of England’s policy announcement on Thursday.
Expectations of interest rate cuts in China have driven a strong rally in the bond market this month while the yuan has been squeezed by flight from China’s crumbling equity markets.
The Chinese currency held at 7.1771 on Wednesday, down 1% for the month. China’s manufacturing activity in January contracted for a fourth straight month, an official survey showed, suggesting the sprawling sector was struggling for momentum.
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