Dollar slips after soft US inflation data

By Laura Matthews

NEW YORK, July 14 (Reuters) - The dollar weakened against major currency peers on Tuesday after softer-than-expected U.S. inflation in June tempered expectations for U.S. Federal Reserve policy tightening.

Analysts said the relief may prove temporary with the U.S.-Iran conflict pushing energy prices higher and keeping prospects of an interest-rate hike later this year alive.

The dollar index was last down 0.35% at 100.91, paring some of its earlier losses following Fed Chair Kevin Warsh's first semiannual testimony to Congress.

Warsh told lawmakers the central bank has "no tolerance for persistently elevated inflation" and that if the Fed gets policy right, "the inflation surge of the last five years will be a thing of the past." Analysts said it would take time to clarify the inflation outlook. 

"With inflation having remained above target for years, alongside renewed geopolitical tensions that keep energy-driven inflation risks elevated and Trump's shift from the proposed 20% protection fee toward trade and investment deals, the broader inflation outlook remains uncertain despite the softer CPI report," said Uto Shinohara, senior investment strategist at Mesirow Currency Management. He was referring to U.S. President Donald Trump dropping a plan to charge a transit fee on shipping through the Strait of Hormuz.

ATTACKS RESUME IN THE GULF

U.S. and Iranian forces traded attacks in the Gulf, where maritime traffic through the strait has come to a near-standstill, pushing oil above $85 a barrel. As a result, investors are now pricing in a higher chance of global interest rates rising this year.

With uncertainty over how long the latest tit-for-tat exchanges might last and how they might affect the flow of oil to world markets, investors are focused on the outlook for price pressures. 

The odds of a July rate increase dropped to 16% from 42% on Monday, according to CME's FedWatch tool, although the odds of a rate hike this year were more robust at 80%, down from 89% on Monday.

Federal Reserve Governor Christopher Waller said on Monday rates may need to rise "in the near term" if data shows inflation remaining well above the central bank's 2% target.

"If Chair Warsh is serious that the inflation surge of the last five years will be a thing of the past, one must consider if this tightening cycle ends up being a bit more painful than currently expected," said Shawn Snyder, economic strategist at Potomac Fund Management. "If that is the case, the dollar could see renewed strength down the road."

The euro gave up some gains and was last up 0.38% at $1.1424. Sterling last traded up 0.27% at $1.3382.

Overnight currency volatility jumped, reflecting nervousness among traders. Overnight implied volatility for the euro, which reflects demand to hedge against large, immediate swings in the currency, briefly topped 10% on Tuesday, something that has rarely happened since April.

"Let us see if all tariff-related talk can go away so that there is indeed some reprieve to customers after being afflicted by the stubborn pace of inflation," said Juan Perez, director of trading at Monex USA. "Suppliers have confessed that they are at their limit in preventing increases in costs being reflected in customer pricing."

YEN VULNERABLE

The Japanese yen rose 0.15% to 162.17 per dollar on Tuesday, hovering near 40-year lows, which kept traders on alert for signs of possible official buying from Tokyo.

The Japanese currency briefly strengthened following comments from Finance Minister Satsuki Katayama that Tokyo may consider adjusting state pension fund asset allocations if the environment surrounding asset management changed sharply.

Health Minister Kenichiro Ueno told a separate press conference on Tuesday that the ministry would examine the Government Pension Investment Fund's asset allocation if needed, but downplayed the prospect of any near-term changes.

"In order for yen-buying pressure from a review of GPIF's asset allocation to be sustained, the decision would likely need to be made quickly, and the increases in the allocation to domestic assets would probably need to be at least five percentage points" in stocks and bonds each, said Masafumi Yamamoto, chief currency strategist at Mizuho Securities.

(Reporting by Laura Matthews in New York; additional reporting by Amanda Cooper in London and Satoshi Sugiyama; Editing by Thomas Derpinghaus, Kate Mayberry, Susan Fenton, Colin Barr, Sharon Singleton, Rod Nickel)