Dollar drops as U.S. inflation appears contained

By David McMahon

NEW YORK (Reuters) - The dollar fell against the euro on Tuesday after a reading of U.S. consumer prices suggested inflation was well contained, backing a view that U.S. interest rates would lose their premium over European rates.

The euro's gains against the dollar also helped push it to a fresh record high against the yen. The euro has risen across the board over the past two months on expectations that euro-zone interest rates will continue to rise.

In contrast, the dollar has suffered from a view that the Federal Reserve will likely cut interest rates from the current level of 5.25 in the second half of this year to shore up a slowing economy.

"We're one step closer to removing the inflation bias from the Fed statement with today's CPI," said Michael Woolfolk, senior strategist at The Bank of New York.

"This further supports the Fed's case that slower U.S. growth will bring core inflation back into line with price stability without resorting to higher interest rates. That's good for stocks and bonds and bad for the dollar," he added.

The euro EUR= last traded up 0.4 percent at $1.3595. One trader said the currency got a boost from European investors repatriating their share of the U.S. Treasury's quarterly payout of Treasury coupons on Tuesday.

The euro rose to a peak of 163.67 yen on electronic trading system EBS, its highest level since the launch of the common European currency in 1999. It later retreated to 163.64 yen

EURJPY=.

The dollar also came under mild pressure after data showed international investors bought a net $45 billion of U.S. securities in March, far less than the roughly $64 billion needed to finance that month's trade deficit.