* U.S. core CPI falls short of market expectations
* Sterling bought back on slight easing in hard Brexit fears
* Mexican peso
By Hideyuki Sano
TOKYO, Oct 19 (Reuters) - The dollar stepped back from seven-month high against an index of currencies on Wednesday after U.S. consumer prices showed underlying inflation moderated slightly, prompting markets to trim bets on a December Federal Reserve rate hike.
The dollar’s index against a basket of six major currencies stood at 97.90, off Monday’s seven-month high of 98.169.
The so-called core CPI, which strips out food and energy costs, gained 0.1 percent last month after climbing 0.3 percent in August, slowing the year-on-year increase in the core CPI to 2.2 percent following a 2.3 percent rise in August.
Fed fund futures <0#FF:> imply around a 65 percent probability of a move, down from 70 percent.
“There was a bit of correction on the dollar’s broad strength. The dollar’s decline was notably against sterling most, as the British currency was heavily shorted,” said Yukio Ishizuki, currency strategist at Daiwa Securities.
The pound rose 0.95 percent on Tuesday, its biggest gain in six weeks, to hit one-week high of $1.2326.
Short-covering was triggered after a UK government lawyer said parliament would “very likely” have to ratify any deal to take Britain out of the European Union, and following stronger-than-expected inflation numbers.
Investors generally assume British lawmakers as a whole are less in favour of a hard line on Brexit than Prime Minister Theresa May and the ministers she has put in charge of negotiations.
The euro also slipped to $1.0980, just above Monday’s 2 1/2-month low of $1.0964.
A break of that level could open the way for a test of $1.0912, a low marked on June 24 in the wake of the Brexit vote.
The common currency is weighed by wariness ahead of the European Central Bank’s policy meeting on Thursday.
The bank is widely expected to keep its policy unchanged with any decisions on the future of its asset purchase scheme expected to be deferred until December.
But some traders are nervous the ECB chief Mario Draghi could take a dovish stance to counter recent talk that the ECB is considering tapering its asset purchases.
The yen was little moved at 103.87 to the dollar.
The Mexican peso, closely watched because Mexico is seen as most vulnerable to Republican Donald Trump’s economic policy proposals, hit a six-week high of 18.5945 pesos to the dollar as Trump’s poll numbers decline.
The peso recovered more than 7 percent from its record low touched last month as investors now see limited chance that Trump will win.
The Australian dollar hit a two-week high of $0.7690 following comments from Reserve Bank of Australia Governor Philip Lowe on Tuesday that he was comfortable with the current exchange rate.
The Aussie was also helped by gains in the kiwi following strong reading in New Zealand inflation data, which stoked expectations that the Australian third quarter inflation data, due next week, could also surprise on the upside.
It stood at $0.7680, awaiting a run of Chinese economic data including July-September GDP to be published, the main event of the day in Asia.
China’s economic growth likely steadied at 6.7 percent although slumping private investment, surging debt and the risk of a property correction remain concerns for investors. (Reporting by Hideyuki Sano; Editing by Eric Meijer)