By Ritvik Carvalho

LONDON (Reuters) – The euro fell on Wednesday, under pressure after a European Central Bank official said the bank was monitoring the currency closely, while the dollar perked up ahead of the Federal Reserve’s first meeting of the year.

ECB governing council member Klaas Knot said the central bank has room to cut its deposit rate further, should it be necessary to improve financing conditions and reach its inflation target.

Knot’s comment constituted the most explicit hint to date from an ECB policymaker about the possibility of a rate cut to stem a rally in the euro – a move that seemed highly unlikely until recently.

The single currency is up almost 15% since March last year, against a dollar that most analysts expect to decline further. Knot’s comments came as the euro, already weaker on the day, extended losses against the greenback.

It last traded 0.3% lower at $1.2120.

Analysts said reports on Tuesday that the ECB was studying whether differences with the Fed’s policy in the United States were boosting the euro – part of a wider review of financing conditions – would not have a material effect on the currency.

It’s “probably one of those headlines where it’s a buy on the dip moment in euro/dollar here,” said Jordan Rochester, FX strategist at Nomura in a note to clients. He remains long on the pair with a target of $1.25 by the end of March.

Alexandre Dolci, G10 FX strategist at BBVA, has a similar outlook.

“Despite the heavy positioning, we continue to favour buying euro/dollar on dips as we see the pair steadying in a $1.20-$1.25 range,” he said.

ECB President Christine Lagarde has repeatedly said the central bank is carefully monitoring the single currency’s exchange rate.

“We suspect they might find that higher inflation is more credible in the US and that euro/dollar spot is closer related to the global manufacturing sector (which is doing well), not European services and maybe, that expectations are elevated in terms of Europe’s comeback,” said Lars Sparresø Merklin, senior analyst at Danske Bank. “Either way, this adds to a growing number of countries who appear uncomfortable with USD weakness.”

The dollar reversed early declines in Asia to trade up 0.3% at 90.393 as markets waited for comments from Federal Reserve Chair Jerome Powell, who is likely to renew a commitment to ultra-easy policy.

Powell is due to speak at a news conference after the central bank’s two-day policy meeting, which ends Wednesday.

Earlier this month, he said in a web symposium with Princeton University that the U.S. economy is still far from the Fed’s inflation and employment goals, and it is too early to discuss altering monthly bond purchases.

“While the Fed had been consistent for the past few months that the balance of risks was still to the downside, we could see a more neutral stance being taken,” said John Velis, FX and macro strategist at BNY Mellon.

“This would be seen as a marginally hawkish turn on the Committee, but we think that the Chair will make it quite clear that neither interest rate rises nor any quantified timeline for tapering bond purchases is under consideration.”

Graphic: Federal Open Market Committee Projections, https://fingfx.thomsonreuters.com/gfx/mkt/dgkplkqagvb/Pasted%20image%201611737561069.png

Elsewhere, the British pound climbed to its highest since May 1, 2018 at $1.3753 before trading flat at $1.3730. [GBP/]

The Aussie dollar slipped 0.4% to 77.18 U.S. cents, paring Tuesday’s 0.5% rally.

(Reporting by Ritvik Carvalho; editing by Larry King, Kirsten Donovan)