Dollar eases as market awaits key inflation data

By Herbert Lash and Samuel Indyk

NEW YORK/LONDON (Reuters) - The dollar eased versus most major currencies on Monday amid expectations key U.S. data this week will show a slowing pace of inflation and growth at a time European economies have surprised to the upside and could be bolstered by interest rate cuts.

The dollar has outperformed this year on the narrative of U.S. exceptionalism, as much of the world was still in recovery mode from the pandemic while the U.S. economy was surprisingly strong.

The Federal Reserve is now expected to cut rates by 25 basis points as early as September and perhaps again in December, a recent shift from an outlook that feared the U.S. central bank might even raise rates again to tame "sticky" inflation.

The economic picture is changing somewhat in the second quarter and dollar strength could fade with weaker employment data as suggested by last week's jobless claims, said Kaspar Hense, senior BlueBay portfolio manager at RBC GAM in London.

"We think the data is softening a bit, not only inflation but also the labor market," Hense said. However, "there is a question mark on inflation and if inflation will be constantly and significantly higher in the U.S. as it has been."

The consumer price index on Wednesday is expected to show core CPI rose 0.3% month-over-month in April, down from 0.4% the prior month, according to a Reuters poll.

The Fed will cut its key interest rate twice this year, starting in September, according to a stronger majority of economists polled by Reuters who broadly raised their inflation forecasts for a second consecutive month.

"The dollar seems to be driven by rates to a large extent. Some of the dollar strength could fade into weaker employment data," Hense said.

While the market expects inflation to decelerate, Fed Vice Chairman Phillip Jefferson said on Monday that until it's clear price pressures are moderating, he supports holding rates steady.

U.S. retail sales also will be reported on Wednesday and industrial production on Thursday.

Marc Chandler, chief market strategist at Bannockburn Global Forex in New York, said softer CPI, softer retail sales and softer industrial production should weigh on the dollar because it helps reaffirm the cap on interest rates.

"We should also get more data in the coming days that Europe is recovering," he said, referring in particular to the ZEW indicator for economic sentiment in Germany.

Markets are pricing in about an 80% chance policymakers will cut rates when they meet in September, with almost 44 basis points (bps) of reductions in total expected in 2024, LSEG data shows.

The dollar index, which measures the U.S. currency against a basket of six peers, fell 0.11% to 105.20, while the euro was up 0.16% at $1.0788. Sterling was up 0.27% at $1.2558 before labor market data on Tuesday.

INTERVENTION JITTERS

Regarding the yen, traders are wary of the continuing risk of currency intervention by Japanese authorities.

The dollar has again crept up against the yen after a 3% decline early in May, its steepest weekly percentage drop since early December 2022 after two bouts of suspected intervention by Japanese authorities to strengthen its currency.

The spikes in yen strength appear to have spooked some yen bears, at least for now.

The dollar strengthened against the yen 0.26% to 156.20, its strongest since May 2.

The yen was briefly supported when the Bank of Japan sent a hawkish signal by cutting its offer amount for a segment of Japanese government bonds in the Asian morning.

China's offshore yuan rose 0.07% to 7.2399 while the onshore yuan fell to its lowest since April 30 at 7.2332, as traders waited for the United States to announce new China tariffs.

The Chinese central bank said over the weekend that new bank lending fell more than expected in April and broad credit growth hit a record low.

Separate data on Saturday showed Chinese consumer prices rose in April while producer prices extended declines.

Bitcoin gained 3.69% at $62,713.00.

(Reporting by Herbert Lash; additional reporting by Samuel Indyk and Brigid Riley; Editing by Jonathan Oatis and Nick Zieminski)