Dollar drops vs yen, near 9-month low to euro on central bank bets

The US dollar dropped against the yen on Friday as traders bet a hawkish pivot from the Bank of Japan (BOJ) was still in the offing.

The dollar also sagged close to a nine-month low versus the euro, amid market expectations the European Central Bank next week will implement a rate hike twice as big as the Federal Reserve's.

The US currency dropped 0.43% to 129.65 yen in early trading, after data showed consumer price inflation in Tokyo accelerating to a nearly 42-year peak this month, ramping up pressure on the BOJ to step away from stimulus.

However, that was still well away from the 7-1/2-month trough of 127.215 reached last week as expectation built then for the central bank to tweak policy. When BOJ officials voted unanimously on 18 Jan to keep stimulus settings unchanged, the currency pair bounced as high as 131.58.

"Market expectations for changes at any time (by the BOJ), including the next meeting in March, will remain high, and that will keep the yen bid," said Shinichiro Kadota, a strategist at Barclays in Tokyo, who saw a possibility of the dollar-yen pair breaking below 125.

"If there are any bouts of yen weakness, I think the topside will continue to be capped by those expectations," Kadota said.

For the week, the dollar is about flat against the yen, after swinging between gains and losses.

By contrast, the euro is headed for a 0.4% rise since last Friday in its third straight winning week. It was 0.07% stronger at $1.08975 on the day, edging back towards the overnight high of $1.09295, a level last seen in April.

Traders broadly expect the Fed to increase interest rates by 25 basis points (bps) on Wednesday, a step down from a 50 bps increase in December FEDWATCH. Meanwhile, the ECB has all but committed to raising its key rate by half a percentage point on Thursday. 

The dollar index - which measures the currency against six major peers, including the euro, yen and British pound - edged 0.04% lower to 101.70, putting it on course for a 0.28% decline this week. That would be its third straight weekly slide.

Sterling was also set for a third winning week against the greenback, eking out a 0.1% rise. It was flat on Friday at $1.2411.

The British currency remains near the seven-month peak of $1.24475 reached at the start of this week, even as traders are still concerned about the task facing the Bank of England in controlling inflation without damaging an economy already in recession.

The risksensitive Aussie dollar rose 0.11% to $0.71225, bringing it closer to Thursday's seven-month high of $0.71425. Australian inflation data earlier in the week showed consumer prices climbing at the fastest pace in 33 years, fostering expectations that more Reserve Bank of Australia interest rate rises are due.

For the week, the Aussie is up 2.17%, on track for its biggest weekly advance since early November.