Dollar rises with Wall Street ahead of FOMC

By Richard Leong

NEW YORK (Reuters) - The dollar rose on Tuesday, as Wall Street rallied on solid retail sales data that supported the view of a steady U.S. economic expansion and which could tip the Federal Reserve towards raising interest rates later this week.

The greenback rebounded from about a three-week low and erased losses against the yen that had strengthened earlier

after the Bank of Japan refrained from further monetary stimulus as expected.

"With the U.S. equities rally, we are seeing a move out of a flight to safety (trade)," said Richard Scalone, co-head of foreign exchange at TJM Brokerage in Chicago.

The dollar index <.DXY> rose 0.4 percent to 95.605, above the 94.913 level set on Monday which was its lowest since late August.

The greenback was up 0.2 percent versus the yen at 120.44 yen , while the euro fell 0.4 percent to $1.1271 .

Major U.S. stock indexes rose more than 1 percent.

Traders have scaled back bets that the Federal Open Market Committee, the Fed's policy-setting group, will end its near-zero rate policy on Thursday as this summer's global market turmoil over concerns about the Chinese economy may have overshadowed further improvement in the U.S. labor market.

Interest rate futures implied traders see about a one-in-four chance the FOMC will raise rates this week, although they still reckon the Fed will raise borrowing costs by year-end.

Weak U.S. manufacturing data mitigated a decent rise in

retail sales in August but did little to sway these views.

As investors wait to see whether the Fed may raise rates for the first time since 2009, the BOJ stood pat.

BOJ Governor Haruhiko Kuroda maintained his optimism that the Japanese economy will continue to recover moderately, although some traders had hoped for a surprise easing because of recent weak data.

"Further monetary easing is still on the table despite Kuroda's upbeat message on the economy," said Omer Esiner, chief market strategist at Commonwealth Foreign Exchange Inc. in Washington.

The Japanese currency clung to a 0.2 percent gain versus the euro at 135.73 yen .

Sterling fell 0.6 percent to $1.5330 after data showed subdued U.K. inflation in August, tempering the case for a rate increase by the Bank of England this year.

The lack of inflation is the central argument against a rise in U.K. rates, but jobs and wage growth have been more positive, supporting a view that the BoE will follow the Fed in lifting rates in early 2016.

(Additional reporting by Anirban Nag in London and Hideyuki Sano in Toyko; Editing by Larry King and James Dalgleish)

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