FOREX-Dollar subdued as low inflation alters Fed calculus

Tue Apr 30, 2013 1:23am 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.

Weighing on the dollar was a slide in the two-year Treasury yield to a nine-month trough of 0.21 percent after data the previous day showed a slowdown in a key measure of U.S. inflation.

The dollar index last traded at 82.143 , 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 eventually 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 longer-dated U.S. Treasuries and mortgage-backed bonds every month. It is expected to vote to keep doing so at its two-day policy-setting meeting this week.

Minutes of the Fed's recent policy meetings had shown that there was increasing debate within the U.S. central bank about the risks and benefits of its asset buying programme.

That had made investors increasingly wary that the Fed could begin scaling back its bond buying later this year. Such jitters, however, have eased due to a string of soft data.

"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 0.1 percent to 97.84 yen. The greenback had slipped to as low as 97.35 yen on Monday, its lowest level in almost two weeks.

The euro held steady at $1.3096. The euro had risen 0.5 percent on Monday 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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