Dollar bounces as risk appetite returns

LONDON: The dollar edged higher on Monday, after posting its biggest weekly drop in two months, as a revival in interest in riskier assets prompted some investors to cut short bets against the greenback before U.S. inflation data this week.

Despite the bounce, net short bets against the dollar remain near their highest levels since January 2013 as expectations of Federal Reserve policy tightening have faded.

Currency markets now expect only one U.S. rate increase by the end of 2018, a sharp decline in expectations from a rate hike before the end of this year a few weeks ago.

"The market is searching for dollar positive news and unless we see a sustainable catalyst for a turnaround, the longer term dollar trend is likely lower," said Richard Falkenhall, a senior FX strategist at SEB.

U.S. inflation data later this week is unlikely to show a significant pick up in price pressures with the August reading forecast to have risen 1.6 percent on an annual basis versus 1.7 percent in July. The Fed has a 2 percent inflation target.

The dollar added 0.6 percent against its Japanese counterpart to 108.49 yen, moving away from a 10-month low of 107.32 yen touched on Friday.

The dollar index, which tracks the U.S. unit against a basket of six major currencies, was 0.2 percent higher at 92.51, after skidding to a 2-1/2 year low of 91.011 on Friday.

"We have seen investors selling dollars for several weeks now and the weekend combination of risk sentiment getting better and China's reserve requirement news has led to some much needed good news for the greenback," said Alvin Tan, an FX strategist at Societe Generale in London.

World stocks climbed to a record high on Monday as investors breathed a sigh of relief after North Korea marked the 69th anniversary of its founding on Saturday without any further missile or nuclear tests, fuelling some unwinding of safe-haven bets such as gold and bonds.

Elsewhere, the euro tumbled towards the day's lows and bond yields eased after ECB board member Benoit Coeure said improved euro zone growth could offset some of the negative effects of the euro's strength but a persistent exchange rate shock could drag down inflation.

Coeure added that given the persistent challenges faced by the ECB in raising consumer prices, its definition of 'medium-term', the time horizon required to meet its inflation target, would be longer than usual.

The single currency fell below $1.20 after his comments to a low of $1.1935 before recovering partially.

The dollar's gains were also helped by news that China's central bank plans to scrap reserve requirements for financial institutions settling foreign exchange forward yuan positions with effect from Monday, according to four sources with direct knowledge of the matter who spoke to Reuters last Friday.