Dollar pauses as benign US inflation cools Fed hike bets

The dollar's advance stalled on Thursday as benign U.S. inflation data prompted traders to scale back expectations for an imminent Federal Reserve interest rate hike. The greenback held steady against the yen in midday Asian trading, though it remained poised for a weekly gain as markets re-established long dollar-yen positions after recent joint U.S.-Japan intervention.

The dollar index, a measure against six major currencies, was flat at 100, heading for a 0.4% weekly rise. U.S. consumer prices rose 0.1% in July, meeting economists' forecasts. This led money markets to lower the probability of a September rate hike to 40%, down from 54% a week earlier, according to CME Group's FedWatch tool.

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We think that the FOMC is likely to maintain a restrictive holding pattern in September rather than a pivot towards a hike.

Michael Wan, a currency strategist at MUFG, noted the Federal Reserve's challenge: balancing inflation risks against a weakening labor market, especially after a softer-than-expected July payrolls report. "We think that the FOMC is likely to maintain a restrictive holding pattern in September rather than a pivot towards a hike," Wan stated.

The dollar traded near 159.44 yen, approaching the 160 level that some market participants view as a critical threshold. This level was last tested before the late July intervention, which helped pull the dollar-yen pair down from a near four-decade high. Shusuke Yamada, head of Japan FX/rates research at Bank of America, indicated that authorities' commitment to defending the yen would be judged by price action and subsequent policy responses. A break above 160 could signal waning resolve, while a sustained drop below 155 might reinforce perceptions of strong commitment.

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A break above 160 would likely be interpreted as a sign of limited policy resolve, while successful intervention that pushes USD/JPY below 155 would have strengthened perceptions of strong commitment at least until recently.