Dollar gains on year-end deals, inflation outlook

NEW YORK (Reuters) - The dollar rose against the euro on Monday, boosted by year-end transactions and speculation that U.S. inflation may cause the Federal Reserve to be less aggressive in cutting interest rates next year.

The U.S. central bank is still expected to lower benchmark rates again in 2008 to shield the economy from a slumping housing market, but analysts think lurking price pressures could force officials to adopt a slower pace of monetary policy easing by keeping rates unchanged when they meet on January 30.

This would not significantly erode the dollar's yield advantage, since global growth worries are likely to prompt other major central banks to cut rates or hold them steady.

"U.S. economic data has been supportive of the dollar, particularly the inflation numbers, and you've seen a scaling back of expectations for Fed easing," said Nick Bennenbroek, senior currency strategist at Wells Fargo in New York.

Data last week showed U.S. consumer prices posted their biggest gain in more than two years in November, with even the report's nonfood, non-energy "core" component beating forecasts.

In mid-afternoon New York trade, the euro traded down 0.3 percent at $1.4380, after earlier dipping to 1-1/2-month low of $1.4332 in overseas trade.

The dollar index, which tracks the greenback's performance against a basket of currencies, touched a two-month high of 77.804 .DXY overnight, before retreating to 77.471, down 0.1 percent on the day.

The dollar fell 0.1 percent to 113.20 yen, also hurt by weaker U.S. equities as investors worried that rising inflation and signs of weak holiday retail sales would further darken the economic outlook for the world's largest economy.

Interest rate futures are pricing in about an 80 percent implied chance of a quarter-percentage-point interest rate cut in January, down from around 100 percent last week. Earlier on Monday, the implied chances of a rate cut had slipped to around 70 percent.

Analysts said year-end transactions were also behind the dollar's advance against the euro zone single currency.

"There is position squaring and there is profit-taking following a year in which the dollar was under a lot of pressure," said Stephen Malyon, currency strategist at Scotia Capital in Toronto.

The return of risk aversion as major central banks prepared to put into practice measures announced last week to help boost liquidity in cash-strapped money markets pushed the dollar weaker against the yen.

The Fed is due to offer the first $20 billion of 28-day funds through its Term Auction Facility on Monday, with the European Central Bank and the Swiss National Bank also offering cash.

News of an unexpected surge to $114 billion in U.S. long-term capital inflows in October, sharply higher than September's inflows of $15.4 billion, gave some support to the dollar, but analysts were a bit skeptical on the relevance of the data.

"The dollar was weaker when all of these flows were occurring, detracting from the relevance in using this data as a rear-view mirror indicator, not to mention its relevance for providing steer going forward," said Alan Ruskin, chief market strategist at RBS Greenwich Capital in Connecticut.

"The data will still leave the debate wide open as to whether the dollar's most recent recovery is predicated on higher dollar yields/rate spreads, or represents an early start to better dollar seasonals in January," Ruskin said in a note.

(Additional reporting by Lucia Mutikani; Editing by James Dalgleish)