Dollar pressured by decline in U.S. inflation

(Reuters) – The dollar edged lower on Wednesday after a surprise fall in U.S. inflation last month reduced expectations that the Federal Reserve would raise interest rates at this week’s monetary policy meeting.

The greenback had traded higher before the U.S. data, underpinned by lofty U.S. yields in the wake of upbeat consumer spending data on Tuesday.

But the unexpected 0.1 percent decline in U.S. consumer prices in August, the first since January, wiped out the dollar’s gains.

As a result, money market traders stuck to their view that the Fed was unlikely to raise rates on Thursday.

"Hopes for a Fed rate hike Thursday grew a bit slimmer after another tame reading of U.S. inflation," said Joe Manimbo, senior market analyst, at Western Union Business Solutions in Washington.

A day before the Fed announces its interest rate decision, overnight indexed swap rates implied traders see a 29-percent chance the Fed will end its near-zero interest rate policy on Thursday, little changed from late Tuesday, according to data from Tullett Prebon.

Traders, on the other hand, placed a 49-percent chance the Fed will tighten policy next month.

In mid-morning trading, the dollar index was down 0.1 percent at 95.474, nowhere near the highs of 96.616 hit in early September. Still the index was off a two-week low struck on Monday, on doubts about whether the Fed will hike rates.

The euro was slightly up at $1.1271, gaining ground after earlier losses triggered by soft euro zone inflation numbers. The euro zone inflation report kept alive expectations that the European Central Bank would extend quantitative easing in coming months.

The dollar was up 0.2 percent against the yen at 120.52 yen , with the Japanese currency largely shrugging off a lowering of Japan’s sovereign credit rating by Standard and Poor’s.

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Earlier, two-year Treasury yields reached their highest in more than four years and long-dated U.S. yields their highest in nearly two months ahead of the two-day Fed meeting that starts on Wednesday.

The rise in two-year yields widened the spread between U.S. and German government bonds to its highest in eight years, initially helping the dollar recover.

Volumes were on the low side, with most investors preferring to stay on the sidelines before the Fed decision. (NEW YORK, Sept 16/2015)

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