Dollar drops as optimism spreads before Fed decisions

The US dollar sank from a one-week high against a basket of major peers on Tuesday as the mood in financial markets brightened ahead of Federal Reserve and Bank of England (BoE) meetings this week.

Both the Fed and the BoE are expected to hike interest rates by 75 basis points (bps) in meetings on Wednesday and Thursday respectively.

Traders then expect the BoE to slow down and raise rates by 50 bps in December, and hopes have risen that the Fed could do the same at its meeting that month.

The US dollar index - which measures the greenback against six rivals, including the euro, sterling and yen - sagged 0.57 per cent to 110.9 on Tuesday, eating away some of the 0.79 per cent gains it made on Monday.

"The feeling is maybe the Fed will tone down the magnitude of hikes, but certainly the message will be the job is not yet done, inflation remains well entrenched," said Rodrigo Catril, a currency strategist at National Australia Bank.

"Our general sense is that the dollar probably has peaked, but that doesn't necessarily mean it's coming down." Sterling rose 0.74 per cent to $1.1551 after dropping more than 1 per cent on Monday. The euro rallied 0.54 per cent to $0.9934.

The dollar index has surged more than 15 per cent this year as the Fed has hiked rates hard, crushing other currencies and heaping pressure on the global economy.

Investors have therefore taken cheer from speeches and interviews by some Fed officials that have suggested the central bank is considering slowing down in December.

However, markets were reminded that global inflation remains stubbornly high on Monday when data showed euro zone prices surged by the most on record in the year through October.

"This is a market that's desperately craving a slowing of the tightening cycle," said Craig Erlam, senior currency analyst at Oanda.

He added: "I think a lot of the move we're seeing today is effectively an unwinding of the moves yesterday... what we're really seeing is very choppy trading."

Against the yen, the greenback fell 1.01 per cent to 147.25.

On Monday, Japan's finance ministry said it had spent a record $42.8 billion on currency intervention this month to prop up the yen after it dropped to 32-year lows near 152 on October 21.

The risk-sensitive Australian and New Zealand dollars rose from one-week lows amid the broad lift in market sentiment.

The Aussie trailed however after the Reserve Bank of Australia decided to stick with a slower quarter-point pace for rate hikes despite a surprise jump in inflation to a 32-year high in the third quarter.

The Aussie gained 0.88 per cent to $0.6454, but was off earlier highs after the RBA's decision. New Zealand's kiwi surged 1.2 per cent to $0.5885.

The Chinese yuan fell to a near 15-year low against the dollar on Tuesday before paring its losses after the central bank fixed the official guidance rate on the weaker side of the key 7.2 per dollar level for the first time since 2008.