Dollar declines with bond yields before Fed meeting

By Karen Brettell

NEW YORK (Reuters) - The U.S. dollar declined on Wednesday as Treasury bond yields eased and investors looked ahead to next week’s Federal Reserve meeting, when the U.S. central bank is expected to raise interest rates but adopt a cautious tone on the economy.

The dollar against a basket of six major currencies <.DXY> dipped 0.26 percent to 100.23, but held above a three-week low of 99.849 reached on Monday.

“It’s a down day for the U.S. dollar broadly,” said Greg Anderson, Global Head of FX Strategy at BMO Capital Markets in New York. “For the Fed, people are expecting a continued very cautious tone as they raise rates.”

Treasury futures traders are pricing in a 95 percent chance of a rate hike next week, with a further hike only likely in June or later, according to the CME Group’s FedWatch Tool.

Investors were also focused on Thursday's European Central Bank meeting for possible indications on when the central bank may begin paring bond purchases under its quantitative easing program.

Many analysts see any potential taper, however, as unlikely in the near term as inflation in the region remains subdued.

“I don’t think in a real sense the ECB can afford to be hawkish,” said Shaun Osborne, chief FX strategist at Scotiabank in Toronto. “Growth is picking up somewhat, but generally speaking inflationary pressures and inflationary expectations are still very, very weak and that’s their mandate.”

The euro has been a main focus for traders this week after Italian Prime Minister Matteo Renzi's loss in a referendum over constitutional reform on Sunday.

After initially dropping on the news, the euro rallied strongly on Monday and has since held below three-week highs against the dollar as investors wait on the ECB.

Osborne said any further euro strength is likely temporary as investors focus on stronger U.S. growth prospects.

"The broader trends for the market beyond the holiday season should be dictated by stronger growth and rising interest rates in the U.S., and that should be positive for the U.S. dollar," Osborne said.

The euro was last up 0.37 percent against the dollar, at $1.0756, after hitting a three-week high of $1.0796 on Monday.

The Canadian dollar gained 0.3 percent after the Bank of Canada pointed to a "significant" amount of slack in the Canadian economy as it held interest rates steady on Wednesday, but also used language suggesting a rate cut is off the table as global growth picks up.

(Additional reporting by Jemima Kelly in London; Editing by Paul Simao and Meredith Mazzilli)

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