* Dollar index hovers near four-week trough
* Fed likely to reduce stimulus modestly, sound dovish
By Masayuki Kitano and Ian Chua
SINGAPORE/SYDNEY, Sept 18 (Reuters) - The U.S. dollar held near a four-week trough against a basket of major currencies on Wednesday as investors bet that any move by the U.S. Federal Reserve to roll back stimulus will be very modest.
The Fed’s highly anticipated rate review ends later in the day and markets expect the central bank will probably announce a small reduction to its $85 billion monthly bond-buying programme.
Indeed, since the disappointing U.S. nonfarm payrolls report on Sept. 6, markets have scaled back expectations on the size of any pullback in stimulus.
That kept the dollar pinned near a four-week trough against a basket of major currencies. The dollar index inched up 0.1 percent to 81.181, but still wasn’t far from a four-week low of 80.968 set on Monday.
On the yen, the greenback edged up 0.1 percent to 99.24 yen .
The euro held steady at about $1.3354, hovering near a 2-1/2 week peak of $1.3385 reached on Monday. The common currency was further underpinned overnight by a closely watched report that showed German analyst and investor sentiment jumped more than expected this month.
Overall, traders said there was little conviction in the market as investors were unwilling to take fresh positions ahead of the outcome of the Fed’s policy review due at 1800 GMT. Chairman Ben Bernanke will give a news conference after that.
Market consensus is for a cut of $10 billion to the bond-buying stimulus, twinned with a pledge to keep interest rates near zero at least until the jobless rate falls below 6.5 percent. Some analysts reckon the Fed may lower the threshold to 6.0 percent.
Traders said any delay to the tapering may be seen as dovish by markets and could prompt investors to sell the dollar. Conversely a bigger reduction of stimulus could be seen as hawkish, lifting demand for the greenback.
BNP Paribas strategists said their base case scenario is for the Fed to pass on announcing tapering now, but leave the door open for reducing stimulus later in the year.
“If they do elect to announce a tapering of purchases, we expect the pace to be a gentle $10 billion with reduced emphasis on a mid-2014 end point noted at the June press conference,” they wrote in a note.
Roy Teo, FX strategist Asia, for ABN AMRO Bank in Singapore, said ABN AMRO expects the Fed to announce a $15 billion reduction to its monthly bond purchases and also to revise its forward guidance on interest rates by lowering the threshold for the unemployment rate.
Such a scaling back of stimulus by the Fed is likely to help the dollar rise versus the yen over the next few months, especially since the market may start positioning for further monetary easing by the Bank of Japan, Teo added.
“We have 110 for the end of the year,” he said, referring to ABN AMRO’s forecast for the dollar versus the yen.
“We...believe that it’s highly likely that the BOJ will further increase its monetary stimulus, given that it’s more likely than not that (Japanese Prime Minister Shinzo) Abe will increase the sales tax,” Teo said.
“Come the end of this year, we could see the market start to price in that the BOJ would further increase its monetary stimulus,” he said.
BOJ Governor Haruhiko Kuroda said earlier in September that the BOJ stands ready to take further monetary easing steps if a planned sales tax hike or other risks derail the economy on its path to achieving the bank’s 2 percent inflation target.
Under a deal reached last year, before Abe’s government came to power, Japan’s 5 percent sales tax rate is set to rise to 8 percent next April and 10 percent in October 2015.
A big upward revision to Japan’s second-quarter gross domestic product announced last week, has bolstered expectations that Abe will go ahead with the planned sales tax hike, with a decision expected in early October.