Dollar edges up at start of new year but sentiment frail

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By Dhara Ranasinghe

LONDON (Reuters) - The dollar edged up on Monday, pulling away from recent six-month lows against a basket of major currencies, for now.

It has weakened recently as markets bet a U.S. Federal Reserve tightening cycle may be nearing an end and sentiment remained fragile.

And the first trading day of the year was subdued, with many countries including big trading centres such as Britain and Japan closed for a holiday.

The dollar index, which measures the value of the greenback against a basket of other major currencies, was trading up around 0.16% at 103.65 - off roughly six-month lows hit last week at around 103.38.

The euro was down about a third of a percent at $1.0680, but not far off its highest levels since June.

Against the yen, the dollar was a touch softer at 130.94, having hit its lowest levels since August last month.

"There is an attempt by the dollar index to pull higher today but we do see that it is losing a good part of the strength it gained last year," said Ulrich Leuchtmann, head of forex research at Commerzbank (ETR:CBKG).

"After the last Fed meeting, the market was not convinced that the Fed won't cut rates later in 2023. It's going to be an interesting year."

Having raised rates by a total of 425 basis points since March to curb surging inflation, the Fed has started to slow the pace of hikes.

That Fed tightening helped lift the dollar index 8% last year in its biggest annual jump since 2015.

A key focus for markets remain central banks and inflation, as well as signals of how long and deep a recession might prove to be.

International Monetary Fund Managing Director Kristalina Georgieva said on Sunday that 2023 is going to be a tough year for the global economy.

Data from China, meanwhile, showed factory activity shrank for the third straight month in December and at the sharpest pace in nearly three years as COVID infections swept through production lines after the government's abrupt reversal of anti-virus measures.

S&P Global (NYSE:SPGI)'s final Purchasing Managers' Index (PMI) for German manufacturing rose to 47.1 in December from November's 46.2 as fading supply chain problems helped ease the downturn in the sector.

While the euro area economy is also heading for a recession, concerns about gas supply over the winter have eased, meaning a downturn may not be as bad as feared just a few months ago.

Euro zone wages are growing quicker than earlier thought and the European Central Bank (ECB) must prevent this from adding to already high inflation, ECB chief Christine Lagarde said at the weekend.

"The recent euro strength is driven by a mix of things including both the hawkish ECB commentary and hopes of a peak in U.S. rates," said Danske Bank chief analyst Piet Haines Christiansen.

"It is also supported by hopes that the energy supply in natural gas is not as bad a situation as feared."