FOREX-Dollar subdued as low inflation alters Fed calculus

Mon Apr 29, 2013 11:27pm EDT

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* Dollar index hovers near lowest in nearly 2 weeks

* Recent weakness of U.S. data weighs on dollar

* Euro seen capped by expectations of ECB rate cut

By Masayuki Kitano and Ian Chua

SINGAPORE/SYDNEY, April 30 (Reuters) - The dollar hovered near its lowest level in roughly two weeks against a basket of currencies on Tuesday as declining bond yields and slowing inflation put pressure on the Federal Reserve for more action.

Undermining the dollar was a slide in the two-year Treasury yield to a nine-month trough of 0.21 percent as low readings on inflation led some market players to bet on more stimulus from major central banks.

The dollar index last traded at 82.189, not far from a low of 82.035 touched on Monday, its lowest level since April 17.

The Fed kicks off its two-day meeting later in the day and markets are watching to see if a sluggish economic recovery and a slowdown in inflation could not only end talk of tapering bond buying but actually push the central bank into buying more.

"Given the underlying inflation trends, we believe attention should shift to the potential for further accommodation, which may involve increasing the monthly pace of purchases, holding securities for longer or modifying the forward guidance," analysts at Barclays Capital wrote in a note.

The Fed is currently buying $85 billion of debt a month and the talk had been of when it might start to scale back. However, a string of soft data has changed the conversation. See

"Talk that (the Fed's) QE might end this year seems to be receding somewhat, due to the recent weakness of economic data," said a trader for a Japanese bank in Tokyo, referring to the Fed's bond-buying programme.

The dollar edged up 0.2 percent to 97.94 yen. The greenback had slipped to as low as 97.35 yen on Monday, its lowest level in almost two weeks.

The euro slipped 0.1 percent to $1.3088, giving back a bit of the gains it made on Monday, when the single currency rose 0.5 percent after Italy formed a government and ended two months of political uncertainty.

Italian benchmark borrowing costs fell to their lowest since October 2010 at an auction on Monday, after Italy's new prime minister, center-left politician Enrico Letta, named a coalition government on Saturday.

The euro, however still remains some way off this month's high near $1.3200, and further gains may be limited ahead of a European Central Bank policy meeting on Thursday.

A majority of economists polled by Reuters expect the ECB to cut interest rates by 25 basis points to 0.5 percent. A separate Reuters poll of money market dealers showed that they were evenly split on whether the ECB will cut rates on Thursday.

Markets will be keeping a close eye on German consumer sentiment, retail sales and employment data due later on Tuesday. German inflation data on Monday has already surprised on the downside.

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