By Karen Brettell

NEW YORK (Reuters) -The dollar fell to multi-year lows against the euro and sterling on Wednesday but gained on the Japanese yen as traders evaluated expectations for Federal Reserve interest rate cuts and turned attention back to U.S. fiscal policies.

Moves were relatively muted following a sharp drop in the greenback on Monday and Tuesday that came after a ceasefire deal between Israel and Iran.

The dollar gained last week on concerns about rising Middle East tensions, before rapidly falling back this week.

"The market's waiting for the next theme," said Steve Englander, Head of Global G10 FX Research and North America Macro Strategy at Standard Chartered Bank NY Branch.

The greenback has also weakened on rising expectations for more interest rate cuts this year.

In his second day of testimony to the U.S. Congress, Fed Chair Jerome Powell on Wednesday repeated that the U.S. central bank should keep interest rates on hold on expectations the Trump administration's tariffs will increase inflation.

On Tuesday, Powell said if not for tariffs, the U.S. central bank would have likely continued to cut rates.

"The market paid attention to that," as it appeared more dovish than Powell’s comments a week earlier at the conclusion of the Fed’s policy meeting, Englander said. "We've had the market bidding up cutting possibilities."

The odds of more rate cuts also rose after Fed policymakers Michelle Bowman and Christopher Waller both recently said that the Fed should cut rates soon.

Fed funds futures traders are pricing in 62 basis points of cuts by year-end, up from around 46 basis points last Friday before comments from the Fed’s Waller. The first cut is fully priced in for September.

Investors "are choosing to interpret Fed Chair Jerome Powell’s Congressional testimony to mean that the central bank is laying the groundwork for an early-autumn rate cut," said Karl Schamotta, chief market strategist at Corpay in Toronto.

TARIFFS BACK IN FOCUS

Investors are also returning their focus to trade negotiations ahead of a self-imposed July 9 deadline by the Trump administration to negotiate deals that avoid reciprocal tariffs with trading partners.

Most likely, this deadline will be extended in order to avoid market volatility as U.S. Congress also works to pass a tax and spending bill due around the same time, said Englander. An extension of the tariff pause would likely be risk positive, and modestly dollar negative. 

The euro gained 0.43% to $1.1658, the highest since October 2021. Sterling rose 0.33% to $1.3659, its highest since January 2022.

The single currency has also been boosted by the expectation of more fiscal spending in the region.

The Swiss franc held near a 10-1/2-year high reached on Tuesday and last traded at 0.804 per dollar. 

The dollar gained 0.18% to 145.17 Japanese yen.

Bank of Japan policymakers called for keeping interest rates steady for the time being due to uncertainty over the impact of U.S. tariffs on Japan's economy, a summary of opinions at the bank's June policy meeting showed on Wednesday.

The Bank of Japan may need to raise interest rates "decisively" to address inflation risks even if uncertainties over U.S. tariffs persist, a hawkish member of its board said, highlighting the bank's attention to growing price pressures.

In cryptocurrencies, bitcoin gained 1.72% to $105,589.

(Reporting by Karen Brettell; Additional reporting by Rae Wee and Amanda Cooper, editing by Ed Osmond and Diane Craft)