Dollar eases as oil prices fall on pause in Middle East conflict

By Saqib Iqbal Ahmed and Medha Singh

NEW YORK, July 27 (Reuters) - The dollar traded with a softer tone against the euro and the yen on Monday as a pause in U.S. bombing in Iran sent oil prices lower and bolstered risk appetite ahead of a busy week of central bank meetings.

The euro rose as much as 0.4% before paring gains to trade about flat on the day at $1.1371, while the U.S. dollar slipped 0.1% to 163.74 yen.

Oil prices sank, with Brent crude futures down $7.78, or 8%, at $89 a barrel after the U.S. military temporarily halted its two-week-long strikes. Tehran said it would also halt attacks if the U.S. maintained the pause, raising hopes for renewed diplomatic efforts to de-escalate the conflict.

Still, the dollar was off the day's lows as the retreat in U.S. yields, which move in the opposite direction of bond prices, was more modest in comparison to the drop in yields in other markets, offering support to the U.S. currency.

"While USD is down on the day, it has been shifting higher in the day as U.S. rates have rallied by less than those in the rest of the world," Benjamin Ford, researcher at macro research and strategy firm Macro Hive, said.

"Overall, that leaves you in a state where the market needs to put front-end rates pricing up against risk premium," Ford said.

The dollar's softer tone comes ahead of the Federal Reserve's July 28 to 29 policy meeting.

With new Fed Chair Kevin Warsh providing few clues on the policy outlook, traders see a roughly 33% chance of a quarter-point Fed rate hike on Wednesday, down from 37% at the end of last week but double the probability seen a week ago, according to CME Group's FedWatch tool.

"The FOMC statement might acknowledge the upside risks to inflation posed by renewed geopolitical conflict, and Warsh might as well in his press conference," Goldman Sachs Chief U.S. Economist David Mericle said in a note.

Investors will also look to U.S. second-quarter GDP data and the Fed's preferred inflation gauge, core PCE inflation, this week for more clues on the health of the world's biggest economy.

POLICY UNCERTAINTY 

The Bank of England and Bank of Japan are widely expected to keep interest rates unchanged at their meetings on Thursday and Friday, respectively, while maintaining a cautious stance on inflation. 

With the yen pinned near last week's 40-year lows against the dollar, the Bank of Japan is expected to leave the door open to further hikes to arrest the currency's decline, although policymakers will likely stay ambiguous on the pace and timing of the moves. Verbal efforts to support the Japanese currency have so far yielded muted results.

"The MoF's intervention window looks increasingly like it has passed," Ford said.

"They need concrete evidence the USD top has been found," added Ford, who sees the risk of intervention beginning to climb once it has become clearer that oil is also shifting lower.

The pound pared early gains to trade about 0.1% lower at $1.3308 ahead of Thursday's BoE meeting. The central bank faces renewed inflation risks from higher oil prices, just days after new Prime Minister Andy Burnham and finance minister John Healey took office.

In cryptocurrencies, bitcoin was about flat on the day at $64,812.

(Reporting by Saqib Iqbal Ahmed in New York, Medha Singh in Bengaluru and Gregor Stuart Hunter in Singapore; Editing by Amanda Cooper, Arun Koyyur and Matthew Lewis)