Dollar stalls as market braces for CPI test, Fed outlook

Markets are pricing in a roughly 56% chance of a cut in September, according to the CME FedWatch tool, down from 77.8% one week ago.

Investors will have a chance to assess the inflation situation when U.S. Consumer Price Index numbers are released at 1830 GMT on Wednesday, just hours before the concludes its two-day policy meeting.

Economists polled by Reuters expect headline consumer price inflation to ease to 0.1% from 0.3% last month, and core price inflation to remain steady on the month at 0.3%.

Meanwhile, the Fed is widely seen holding rates at 5.25% to 5.5%, putting the focus on policymakers' updated economic projections known as the "dot plot" and Chair Jerome Powell's news conference for clues regarding the timing and pace of cuts.

"Consensus seems to be that the number of cuts in 2024 will be downgraded from three currently to two" in the latest dot plot, said Kieran Williams, head of Asia FX at InTouch Capital Markets.

Powell is likely to strike a relatively dovish tone, however, given disappointing growth indicators since the last Fed meeting, Williams said.

The dollar index, which measures the greenback against a handful of other major peers, firmed at 105.29, after touching its strongest level since May 14 at 105.46 overnight.

The euro held steady at $1.073675, keeping off Tuesday's low of $1.07195, its weakest level since May 2.

Sterling was flat at $1.2739 ahead of UK gross domestic production figures for April.

During Asian trading hours, data showed China's rose at a steady pace in May, while producer price declines narrowed slightly, adding to signs that government efforts to prop up the economy were starting to bear fruit.

The offshore Chinese yuan was little changed at 7.2696 per dollar.

BOJ'S BALANCING ACT

The Bank of Japan (BOJ) will also meet this week, where it is widely expected to keep interest rates steady and consider whether to offer clearer guidance on how it plans to reduce its huge balance sheet.

"The BOJ will have to walk a tightrope in its policy meeting this week to avoid inadvertently stoking JPY outflows, while also supporting growth and preventing disorderly JGB markets," said Wei Liang Chang, currency and credit strategist at DBS.

The dollar held the yen pinned at 157.235, although the currency pair remained off the one-week high of 157.40 touched the previous day.

Japan's wholesale inflation jumped in May at the fastest annual pace in nine months, data showed on Wednesday, a sign the weak yen was adding upward pressure on prices.

Although Japan's central bank will likely discuss bond buying cuts to preempt yen selling pressure, Wednesday's U.S. CPI and Fed meeting will be crucial in determining dollar/yen volatility this week, Chang added.

"The hurdle for another upside surprise to U.S. rates and the USD looks quite high though, and we do not expect a retest of the 160 level in USD/JPY," Chang said.

The yen's decline to a 34-year low of 160.245 per dollar at the end of April triggered several rounds of official Japanese intervention totalling 9.79 trillion yen ($62.31 billion).

Overnight implied dollar/yen volatility touched a one-month high of 13.37% on Wednesday ahead of the key events.