Dollar struggles as softer inflation dims Fed hike bets

HONG KONG - The dollar extended its weakness on Wednesday after tumbling from a two-week high, as softer-than-expected inflation data curbed bets on a near-term Federal Reserve rate hike, despite concerns that elevated oil prices could fuel inflation risks.

Against the yen, the dollar fetched 162.08, down 0.1%. The euro and the British pound each gained 0.1%, trading at USD 1.1433 and USD 1.3401, respectively.

The New Zealand dollar was also well bid at USD 0.5819, hovering around its strongest level in a month, and the Australian dollar was steady at USD 0.6983.

The US dollar index, which measures the currency against a basket of six peers, was a shade weaker at 100.81. It fell 0.35% in the previous session for its biggest pullback in nearly two weeks, which dragged the index down from the highest level since July 2.

US consumer inflation slowed more than expected to 3.5% on a year-over-year basis in June. The headline consumer price index fell 0.4% over the month, the first decline since April 2020, as energy prices retreated.

Bond yields fell after the surprisingly soft data dampened market expectations for a near-term rate hike from the Federal Reserve, with yields on two-year US Treasuries off 9 basis points from a 16-month high.

"The sizeable downside surprise gives the Fed greater scope to remain on hold for longer," said Sim Moh Siong, FX strategist at OCBC, noting the central bank officials had signaled its July decision would hinge on the June inflation reading.

"While we continue to expect modest USD appreciation by year-end, near-term upside momentum may remain constrained in the absence of fresh catalysts," he added.

Traders now expect that the Fed will skip a July rate hike as inflation cools. Chances of a July hike were halved to 16% after the inflation reports based on Fed funds futures prices as traded at the CME Group.

However, the optimism was somewhat overshadowed by Fed Chair Kevin Warsh, who said during his testimony before the House Financial Services Committee that the central bank has "no tolerance" for persistently elevated inflation, and vowed to "do my job" if challenged by US President Donald Trump.

In the Gulf, the latest escalation in hostilities in the Iran conflict pushed oil prices back to one-month highs, keeping inflation risks alive.

Trump on Tuesday reimposed a naval blockade of all Iranian ports, while the US military said they have begun a fresh round of strikes "to continue degrading Iranian capabilities used to attack commercial shipping in the Strait of Hormuz."

"One month of softer-than-expected CPI data will not close the door to interest rate hikes," CBA economists Samara Hammoud said in a note, adding that the markets are closely watching the producer prices data due later today.  

(Reporting by Jiaxing Li; Editing by Shri Navaratnam)