Dollar needs more than hawkish talk to rebound

By Vivianne Rodrigues - Analysis

NEW YORK (Reuters) - The dollar likely faces more weakness thanks to the light-footed tack taken by the Federal Reserve, which signaled on Wednesday it was in no rush to raise interest rates even as other central banks appear bent on raising borrowing costs soon.

The Fed did as expected and held its key benchmark interest rate steady at 2.0 percent for the first time since September and voiced greater concern about inflation.

While the Fed's remarks signal the U.S. central bank's next move is to raise rates, its effort to tamp expectations of an increase as early as August was seen at odds with a more aggressive posture from the European Central Bank. The ECB is expected to lift rates in July, leaving currency traders to view the Fed as dovish by comparison.

"The Fed is caught between a rock and a hard place for the next three to six months," said Michael Strauss, chief economist at Commonfund, in Wilton, Connecticut. "There are weaker economic conditions and a slight uptick in inflation."

The dollar fell to a two-week low of $1.5686 against the euro and futures showed just a 33 percent chance of a rate increase by the Fed in August, down from a 48 percent chance before the decision was released. A rate increase was, however, fully priced by the September Fed meeting.

Investors are reluctant to build long-dollar positions around a view of future rate hikes because of uncertainty surrounding the U.S. economy.

Earlier in the month, strong statements from Fed officials about inflation threats had lifted expectations of a rate hike and helped push the dollar up about 2 percent against the euro from a record low of 1.6018 reached in March.

"Euro/dollar has been pretty volatile. I think the market is still trying to figure out what exactly the Fed has said here," said Stephen Malyon, senior currency strategist at Scotia Capital in Toronto. "I think the (dollar's) response is a reflection of the argument that they have left their options open and they are not signaling very strongly to the market what they intend to do next."

Some analysts now say the euro may attempt a rebound to 1.60 as the ECB has flagged a rate increase for the euro zone at its next meeting, from the current 4.0 percent.

"The market doesn't believe that they (ECB) will only hike once and stop. We think there's going to be more than one," said Dixon Fung, head of trading at MG Financial in New York. "They can't come out and say that given the state of the dollar, which would fall below 1.60 per euro if they did. But we think there will be a series of rate hikes over there."

The Fed statement also showed Dallas Fed President Richard Fisher voted against holding rates unchanged and preferred an increase in the target for the federal funds rate at this meeting.

"The fact that Fisher dissented, favoring an immediate hike, is particularly hawkish," said Marc Chandler, senior currency strategist at Brown Brothers Harriman. "However, there is also nothing that indicates a strong sense of urgency that others are on the verge of joining him," reducing the chances of an August rate hike.

"With the ECB poised to hike rates next week, on balance, the dollar may remain under pressure," he added.

(Additional reporting by Richard Leong, Lucia Mutikani and Steven C. Johnson in New York; Editing by Dan Grebler)