Dollar sags as bets build for less hawkish Fed; Aussie firms after CPI

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By Kevin Buckland

TOKYO (Reuters) - The dollar wallowed near a three-week low versus major peers on Wednesday as more signs of economic weakness in the United States fanned speculation about a less hawkish Federal Reserve.

The Australian dollar strengthened to just shy of the previous session's 2 1/2-week high as hotter-than-expected inflation data put pressure on the Reserve Bank ahead of a rate decision next week.

Sterling hung close to the six-week peak reached on Tuesday after new British Prime Minister Rishi Sunak pledged to lead the country out of an economic crisis, and stuck with Jeremy Hunt as finance minister.

The euro also remained near a six-week high, trading less than half a cent from parity with the greenback. The European Central Bank decides policy on Thursday and is widely expected to raise rates by 75 basis points.

The dollar index - which measures the currency against six peers, including sterling, the euro and the yen - was little changed at 111.01, near the previous session's trough of 110.75, the lowest level since Oct. 5.

Data overnight showed that U.S. home prices sank in August as surging mortgage rates sapped demand, amid recent signs that Fed rate increases are already working to slow the world's biggest economy.

Traders and economists predict another 75 basis point increase next Wednesday, but the view is growing for a slowing to half a point in December.

"I'm still in two minds as to whether we can say we've seen a peak in the U.S. dollar," but "evidence of a slowdown is building," said Ray Attrill, head of FX strategy at National Australia Bank (OTC:NABZY).

"If the market gets really comfortable with a Fed pivot - if that's what stepping down to 50 basis points is, and potentially ending a tightening cycle south of 5% early next year - then it will be time to call time on U.S. dollar strength, but I'd like to get through the Fed messaging next week before coming to that conclusion."

U.S. long-term Treasury yields continued their descent from last week's multi-year highs at 4.338%, declining to 4.0941% in Tokyo.

That put pressure on the dollar versus the yen because of its sensitivity to U.S. rates, although it managed a 0.22% gain to 148.265, clawing back some of its 0.7% slide on Tuesday.

The dollar reached a 32-year high at 151.94 yen on Friday, but was then beaten back as far as 144.55 amid two bouts of suspected Bank of Japan (BOJ) intervention either side of the weekend.

Even so, fundamentals still favor a weaker yen, with the BOJ expected on Friday to keep stimulus settings unchanged, running counter to monetary tightening by developed-market peers.

The euro slipped 0.13% to $0.9957, after jumping to its highest since Oct. 5 on Tuesday at $0.9995.

Sterling eased 0.16% to $1.1454, but was still close to Tuesday's high of $1.1500, a level last seen on Sept. 15.

"With Jeremy Hunt confirmed reappointed as Chancellor, we judge the political discount to GBP is fading," Joseph Capurso, a strategist at Commonwealth Bank of Australia (OTC:CMWAY), wrote in a client note.

"However, GBP retains a number of headwinds such as a looming recession and a growing current account deficit," he added.

The Australian dollar added 0.11% to $0.6401, just short of Tuesday's top of $0.6412, the strongest since Oct. 7.

The RBA decides policy on Tuesday, and is now under pressure to either roll back a decision to slow the pace of rate hikes from the previous meeting, or to run its tightening campaign for longer. Both NAB and ANZ raised their forecasts for the RBA's terminal rate following the data.

But while that should lend the currency some support, it has also been battered by poor risk sentiment amid weakness in global stock markets and economic worries around top trading partner China.

"It may take some time for the cloud of gloom over China to lift from AUD," said Sean Callow, a senior FX strategist at Westpac.

"A further pullback in the U.S. dollar seems to be the Aussie's best chance of sustaining pushes above $0.64. Otherwise, it's back to trading either side of $0.63."

Cryptocurrencies were firm after sharp rallies on Tuesday amid dollar weakness. Bitcoin was 0.35% higher at $20,157 after a 3.9% jump overnight. Ether was up 1.3% at $1,479.40, building on Tuesday's 8.7% surge.