NEW YORK (Reuters) - The dollar extended gains against the euro on Tuesday on expectations that the Federal Reserve could raise U.S. interest rates sooner than previously expected, but fell against the yen on safe-haven demand for the Japanese currency.
Traders said that strong U.S. economic data, including the government's nonfarm payrolls report last Friday showing employment returned to pre-recession levels, supported the view that the Fed could take a more hawkish stance on tightening monetary policy at its meeting next week.
Traders' bracing for potential signs of a Fed rate hike earlier than forecast helped push U.S. government bond yields higher, which in turn drew demand for dollars.
"As you get stronger labor market data, stronger activity data, the risk is the market will start pricing in an earlier than expected timing of the first rate increase," said Ian Gordon, FX strategist at Bank of America Merrill Lynch in New York.
Expectations for strong U.S. retail sales data on Thursday, in a week of scarce economic data, bolstered views of a Fed rate hike earlier than previously anticipated, traders said. Traders currently expect the Fed to hike rates in the second half of 2015, based on U.S. short-term interest rate futures.
Upbeat Commerce Department data on Tuesday showing U.S. wholesale inventories rose 1.1 percent in April, beating economists' expectations for a 0.5 percent gain, supported that view.
Traders have said signs of a rate hike are positive for the dollar, since higher U.S. bond yields encourage capital flows into Treasuries. The benchmark 10-year Treasury note was last down 6/32 in price to yield 2.638 percent. Yields hit a one-month high of 2.651 percent.
The U.S. dollar index .DXY, which measures the greenback against a basket of six major currencies, was last up 0.18 percent at 80.799, pulling further away from a near two-week trough of 80.240 touched last Friday. The dollar was up 0.23 percent against the Swiss franc to trade at 0.8991 franc.
The euro was last down 0.35 percent against the dollar at $1.3545 but was still higher than a four-month low of $1.3503 hit last Thursday after the European Central Bank announced its monetary stimulus measures.
Traders said the ECB's move and the potential for further stimulus could continue to weigh on the euro.
"There will be an even more heightened sense of the potential for a move in the ECB ... and that logically should keep pressure on the euro," said Richard Scalone, co-head of foreign exchange at TJM Brokerage in Chicago.
The dollar was last down 0.18 percent against the yen, however, to trade at 102.32 yen. Traders said the downturn in Japanese stocks drove some demand for the safe-haven yen. Tokyo's Nikkei average .N225 closed down 0.85 percent on Tuesday.
Reporting by Sam Forgione; Additional reporting by Patrick Graham in London; Editing by James Dalgleish