LONDON (Reuters) - The dollar retreated slightly from a five-month high on Monday, after its biggest weekly gain since 2022, as the prospect of stubbornly high US interest rates and escalating conflict in the Middle East gave support.
The US currency rose 1.6% against a basket of six major currencies last week after a small but unnerving upside surprise in U.S. inflation cast doubt over bets on US rate cuts, while European policymakers signalled a cut within a few months.
The initial moves in currencies on Monday seemed to be based more on the receding Federal Reserve rate cut expectations than a weekend attack on Israel by Iran, from which the broad market reaction has been relatively muted.
"There are signs of relief around markets following Iran's missile barrage on Israel over the weekend," Shaun Osborne, chief FX strategist at Scotiabank, said.
"For now, the simmering conflict remains contained."
Iran had warned of a strike on Israel and over the weekend launched more than 300 drones and missiles in retaliation for what it said was an Israeli attack on its Damascus consulate. The unprecedented drone and missile volley caused only modest damage and Iran said it now "deemed the matter concluded".
The dollar index, which measures the currency against a basket of six others, was last down 0.1% at 105.86, just below Friday's 5-1/2 month high of 106.11.
Wall Street’s main indexes plummeted on Friday, capping a week marked by hotter-than-expected inflation and jobs data that forced investors to reset expectations for the timing of interest rate cuts.
"If you want a safe-haven currency right now, the dollar is the best place to go," said Chris Turner, global head of markets at ING, citing ample liquidity, high US deposit rates and US energy independence.
The yen was the main loser on Monday, marking a 34-year low at 153.97 to the dollar, reviving anticipation of currency intervention.
Japanese Finance Minister Shunichi Suzuki said on Monday he was watching currency moves closely, and that Tokyo is "fully prepared" to act.
"I think if dollar-yen got up to 155, Tokyo would intervene," ING's Turner said.
"If there was some greater escalation in the Middle East the yen could benefit at the margin because it's the largest short position in the market."
US RATE CUT BETS RECEDE
The dollar stands to benefit as investors continue to slash bets on Fed cuts and push back the expected start of the easing cycle to September after Wednesday's hotter-than-expected consumer price (CPI) report.
"It is a data-light week so all eyes will turn to Fedspeak where more than half a dozen voting members on the FOMC are likely to emphasise patience after last week's blowout CPI print," Nicholas Chia, Asia macro strategist at Standard Chartered Bank, said.
The two-year Treasury yield, which is sensitive to changes in interest rate expectations, surged past 5% on Thursday. The yield was last at 4.95%.
The euro, which recorded its biggest weekly percentage drop since late September 2022 last week as the European Central Bank left the door open to a rate cut in June, was up around 0.2% on Monday at $1.0659 but stayed close to a five-month low of $1.06225 reached on Friday.
The pound had its largest weekly percentage drop since mid-July last week but was also rebounding slightly to $1.2493.
"Sterling is a moderate outperformer on the day, picking up ground with some of the riskier currencies as market jitters ease after the weekend," Scotiabank's Osborne said.
Bitcoin fell below $62,000 on Sunday, losing $10,000 or 15% from highs a week ago. It was last up at $66,209.