Dollar creeps lower as large Fed rate hike looms

By Samuel Indyk

LONDON (Reuters) - The dollar edged further away from recent 20-year highs on Wednesday ahead of the U.S. Federal Reserve policy meeting, at which the central bank is expected to raise rates by another 75 basis points to tame soaring inflation.

But moves in currency markets were modest as traders await the policy announcement at 1800 GMT.

Money markets are betting that the Fed will raise rates by 75 basis points (bps), with an outside chance of a larger 100 bps hike. Traders expect the Fed to take the rate to as high as 3.4% by year-end to help bring inflation back to target.

Bets on oversized rate hikes helped push the dollar index, which measures the dollar against a basket of six currencies, to its highest level in almost 20 years earlier this month at 109.29, with the greenback currently up 2.1% in July.

At 1055 GMT, the dollar index was down 0.2% at 106.93.

"Markets are taking a bit off the table before tonight's Fed meeting," said Simon Harvey, head of FX analysis at Monex Europe. "Barring any imminent headlines on European energy or political developments I think we will see very limited ranges."

The euro edged 0.33% higher to $1.0149 but failed to recoup much of Tuesday's 1.0% slide, its biggest fall in over two weeks, after fears of a European recession escalated when Russia further cut gas supplies to Europe through the Nord Stream 1 pipeline.

Analysts said it remained premature to short the dollar given the gas situation in Europe and rising yields in the European periphery, particularly Italy.

Italy's yields rose further on Wednesday after rating agency S&P Global (NYSE:SPGI) revised its outlook on Italy's rating to stable from positive, pushing the closely watched spread between German and Italian 10-year yields to as wide as 250 bps.

"Most factors are still in favour of the dollar," said Vincent Manuel, chief investment officer at Indosuez Wealth Management. He cited the macro backdrop between the U.S. and euro zone, peripheral spread widening, the European energy crisis and the relative pace of monetary policy normalisation.

The Australian dollar was up 0.12% to $0.69455 as Australian inflation sped to a 21-year high in the last quarter, although the figure was not as high as some investors feared and some rate hike bets were pulled back.

Traders are now pricing in an around 86% chance of a 50 bps rate hike by the RBA next week, and a 14% chance of a more modest 25 bps hike.

The dollar was down 0.2% to 136.69 yen. Against the safe-haven Swiss franc, the dollar was also down 0.2% at $0.9612.

In cryptocurrencies, bitcoin was steady at $21,301.