Dollar supported as bets on 2025 rate cuts evaporate

SINGAPORE (Reuters) - The dollar held firm and near recent peaks on Tuesday, on the eve of an expected interest rate cut in the United States, as traders ratchet long-term rate assumptions higher.

The friendless euro, which is heading for a calendar-year drop of nearly 5% on the dollar, was not far from the year's lows at $1.0518.

The gap between U.S. and German ten-year yields is 216 basis points and has widened nearly 70 bps in three months.

The yen was on the back foot for a seventh consecutive session - and marginally weaker at 154.17 per dollar in morning trade - as markets have pared chances of a Japanese rate hike this week and see a move in January as more likely.

The Federal Reserve announces its interest rate decision on Wednesday and interest rate futures imply a 94% chance of a hike, even as services-sector activity leapt to a three-year high according to an S&P Global purchasing managers survey.

The Atlanta Fed's GDPNow indicator is running at 3.3% for the fourth quarter and the strength of the economy has been lifting yields and supporting the dollar as traders figure this week's expected cut may be the last for a while.

After a cut on Wednesday, markets see about a 37% chance there will be either one 25 bp cut or none at all through the whole of 2025, according to the CME FedWatch tool, up from about 21% a week earlier.

"I think the Fed will now be worried about a resurgence of inflation as an unknown policy mix and sticky prices create many paths for inflation to make a comeback in 2025," said Brent Donnelly, president at Spectra Markets.

"And therefore I think they will signal a very cautious approach going forward and lean on language that suggests concerns about inflation and a higher neutral rate."

Besides the Fed, the Bank of Japan, Bank of England and Norges Bank meet this week and are expected to stand pat on Thursday, while the Riksbank is seen cutting rates, perhaps by 50 basis points.

Sterling bounced on Monday as a survey of business activity pointed to price rises in Britain while labour data is due on Tuesday, with upward pressure on wages seen adding to the case for caution from the central bank. Sterling last bought $1.2695.

The Canadian dollar, squeezed by falling interest rates and the risk of U.S. tariffs, sank to a 4-1/2 year low on Monday as the sudden resignation of Finance Minister Chrystia Freeland put an unpopular government under more pressure.

The Australian and New Zealand dollars are pinned near the year's lows, though were spared any further selling on the latest weak Chinese economic indicators on Monday as markets bet that government spending will ride to the rescue. [AUD/]

The Aussie was last steady at $0.6373 and the kiwi inched up to $0.5792. New Zealand increased its bond issuance forecast for the next few years and long-term yields rose.

China's yuan was under gentle pressure at 7.2918 in offshore trade, as dour expectations for Chinese economic growth pushed 10-year bond yields to record lows.

(Reporting by Tom Westbrook; Editing by Shri Navaratnam)