FOREX-Eyes on euro zone inflation after Fed tempers dollar rally

Thu Jul 31, 2014 4:23am EDT

* Upbeat U.S. Q2 GDP partly offset by mixed Fed views

* Dollar index set for biggest monthly gain in over a year

* Nonfarm payrolls, euro zone inflation are next focus

By Jemima Kelly

LONDON, July 31 (Reuters) - The dollar held just below a 10-month high against a basket of currencies on Thursday after the Federal Reserve said it was in no rush to raise interest rates, tempering a rally that dates back to early May.

Dollar bulls took heart on Wednesday after a report showed the U.S. economy rebounded sharply in the second quarter, with gross domestic product grew at a 4 percent annualised pace.

But the Fed's affirmation of a broadly relaxed stance on monetary policy gave food for thought to those who wanted to push the greenback further.

Adam Myers, head of currency strategy at Credit Agricole in London, said the dollar still looked strong but that gains, particularly against the euro, may be almost over for now. The dollar index is up more than 2 percent so far this month, on track for its biggest monthly gain in more than a year. It traded at 81.457, just off Wednesday's high of 81.545.

"The market is now a little bit too far ahead of itself - there's not going to be any Fed interest rate rises in the first half of 2015 and that's what the market is pretty much pricing in at the moment," he said. "It will only take a weak payrolls number and we'll see quite a snapback."

Data due on Friday is expected to show that U.S. employers added 233,000 new non-farm jobs in July.

The euro was flat in early European trade after hitting a 9-month trough of $1.3366 on Wednesday.

Data on Thursday will show whether euro zone inflation tumbled further in June. Economists polled by Reuters expect it stayed at 0.5 percent but some put the number as low as 0.3 percent.

A lower-than-expected number could fuel expectations of further easing from the European Central Bank and in turn weigh on the euro. Data on Wednesday showed annual inflation in Germany slowed to 0.8 percent in July.

"An outcome in line with our forecast (0.3 percent) would constitute a downward surprise and likely weigh on the euro," said analysts at BNP Paribas in a note. "This should not be a game-changer for the ECB as policymakers will take time to fully implement and assess the impact of the June policy actions."

The two-year Treasury yield jumped to its highest in more than three years at 0.59 percent, which in turn helped boost demand for the U.S. dollar.

Against the yen, the greenback climbed to a four-month high of 103.15, before steadying at 102.80. It was poised to gain about 1.4 percent on the month against the yen.

The dollar also fared well against higher-yielding currencies such as the Australian dollar, which plumbed a two-month low of $0.9301 before edging back to $0.9310, down quarter of a percent. (Reporting By Jemima Kelly; Editing by Larry King)

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