Dollar treads water as Fed hike bets pared on benign US inflation

The dollar's gains slowed on Thursday following a tame US inflation report that led traders to reduce expectations of an imminent Federal Reserve interest rate hike. The greenback hovered around the same level against the yen while still poised to climb around 1% this week following previous joint US-Japan intervention that saw it plummet to a three-month low.

The dollar index, which tracks the US currency against six peers, stayed flat at 100 but was set to rise by 0.4% over the week. US consumer prices rose by 0.1% in July, matching analyst forecasts, prompting money markets to cut the probability of a September rate hike from 54% to 40%, according to CME Group's FedWatch. Michael Wan, a currency strategist at MUFG, highlighted the Fed's dilemma of balancing inflation risks with a cooling labor market, especially after the weaker-than-anticipated July employment report.

Wan expects the Federal Open Market Committee (FOMC) to hold off on a rate increase in September rather than pivot towards a hike. Oil prices fell as demand forecasts turned more pessimistic despite the deadlock in US-Iran talks. The dollar traded at 159.44 yen, near the 160 level viewed by some as a threshold following the rare joint intervention at the end of July.

This helped push the exchange rate down from near a four-decade high close to 164 to 155.20 over the span of three days. Shusuke Yamada, head of Japan FX/rates research at Bank of America, noted that investors can only gauge the authorities' dedication to protecting the yen through dollar-yen price movements and subsequent policy responses.

"A break above 160 would probably signal limited policy resolve, while successful intervention that drives USD/JPY below 155 would have bolstered perceptions of strong commitment, at least until recently," Yamada commented. Confidence in Japan's commitment to defending the yen improved after joint intervention with the US on July 31.

However, with USD/JPY rebounding without any intervention over the past week, that confidence has waned. The euro remained steady at $1.1523, while the British pound slipped 0.05% to $1.3489 ahead of a cascade of UK economic data release. The Australian dollar declined 0.2% to $0.7049 but was still close to its 10-week peak of $0.7091.

The Reserve Bank of Australia's Assistant Governor, Christopher Kent, told a Reuters NEXT Newsmaker event that inflation risks are largely on the upside and if they materialize, rates would need to be increased again. New Zealand's dollar slipped 0.4% to $0.5832, continuing its slow decline from the highest levels since early June, which were earlier this month. Bitcoin remained unchanged around $63,532.