By John McCrank

NEW YORK (Reuters) – The dollar edged lower on Tuesday in thin summer trading with market participants in wait-and-see mode ahead of key inflation figures that could shed more light on how aggressive the Federal Reserve might be in its expected interest rate hike in September.

Traders are widely expecting Wednesday’s U.S. Consumer Price Index report to show that decades-high inflationary pressures eased in July following back-to-back 75-basis point hikes by the Fed in June and July aimed at combating soaring prices.

But data on Friday showed that U.S. employers hired far more workers than expected last month, with wages still rising at a strong clip, temporarily sending the dollar higher as bets rose for another mammoth rate hike by the Fed at its Sept. 20-21 meeting.

Money-market futures show traders see about a two-thirds chance of a 75 bps hike next month.

“We’ve been getting consistently hotter-than-expected inflation reports and if that happens again, the market is not prepared for that,” said Edward Moya, senior market analyst at Oanda. “If that happens, we’re testing parity again against the euro,” he said of the potential for more dollar strength.

The dollar index, which measures the currency’s value against a basket of peers, was 0.226% lower at 106.09 at 10:25 a.m. Eastern time (1425 GMT). The greenback hit a more than one-week high on Friday of 106.93.

The euro was up 0.4% at $1.0233, sterling gained 0.26% to $1.2112. Versus the yen, the dollar was flat, at 134.985 yen.

Economists polled by Reuters see year-on-year headline inflation at 8.7% – relatively high, but below last month’s 9.1% figure. The Fed targets inflation at 2%.

Heightened expectations for aggressive near-term hikes, have pushed short-dated Treasury yields further above long-term peers.

The gap between two and 10-year Treasury yields, a reliable recession indicator, has grown to its largest in two decades. [US/]

“The U.S. yield curve is inverted, suggesting recession down the line. But equity markets look as if they believe the Fed is going to stop soon and start cutting in 2023,” said Mizuho senior economist Colin Asher.

“I think tomorrow’s CPI data will suggest the Fed is not going to stop, which to me suggests weaker equity markets ahead which will limit any dip in the dollar in the next few months.”

The dollar’s safe haven status, though, makes the greenback’s reaction a little harder to predict, especially as growth and geopolitical worries swirl.

China extended military drills near Taiwan, and the self-ruled island’s foreign minister said China was using the drills launched in protest against U.S. House Speaker Nancy Pelosi’s visit as an excuse to prepare for an invasion.

Elsewhere, Australia’s dollar, viewed as a barometer of market risk, and New Zealand’s dollar, were both 0.09% lower at $0.6977 and $0.6280 respectively.

(Reporting by John McCrank in New York; additional reporting by Dhara Ranasinghe in London; Editing by Alex Richardson, David Evans and Susan Fenton)