The dollar slides to a 2-month low against the euro after March inflation data dims view of more Fed rate hikes

• The US dollar dropped to its lowest value against the euro in two months Wednesday.
• The move followed March inflation data showing a slowdown in the headline rate to 5% from 6% in February.

The dollar retreated Wednesday to its lowest level in two months against the euro after cooling inflation in March prompted traders to pare bets on rate hike next month by the Federal Reserve while continuing to see rate cuts coming this year.

The dollar also fell against other major currency rivals, including the Japanese yen, pulling the US Dollar Index to a one-week low of 101.45.

With the greenback weakening, the euro jumped 0.8% to buy $1.1004, the highest value since early February.

The moves followed US inflation report for March, which featured the headline rate rising to 5% year-over-year. But that pace slowed from 6% in February and marked the lowest rate since May 2021, according to the Bureau of Labor Statistics. Economists widely expected a 5.2% reading.

"A modestly softer-than-anticipated US inflation report, which appears to have thrown another Fed rate hike in May in a bit of jeopardy," Matthew Ryan, head of market strategy at Ebury, a foreign exchange services company, said in a note.

Pricing in the Fed funds futures market indicates a 67.2% probability the Fed will raise its benchmark lending rate by 25 basis points at its May 2-3 meeting, a drop from 72.9% on Tuesday. Meanwhile, traders still see the Fed starting to cut interest rates in July to a range of 4.75%-5%, followed by more cuts to the end of 2023 and into 2024.

The dollar sell-off looked like a slight overreaction, said Ryan. "[Core] inflationary pressures, which we assign far greater importance, remain strong. Our favoured metric, the three-month annualised core inflation rate, continues to print well above the Fed's target at 5.1%."

The dollar came under pressure as US bond yields fell, indicating bond traders foresee the Fed getting closer to rate cuts. Higher interest rates can boost government debt yields and bolster a currency's attractiveness as investors seek to buy into relatively richer yields.

Against the Japanese currency, the greenback fell 0.4% to buy 133.190 yen. The dollar's decline boosted the British pound by 0.5% to $1.2462 shortly after the data but has since pared down that move.

The loss was 0.2% against the Canadian dollar.

The Fed looks more than likely to opt for a 10th straight rate increase in May, with major equity indexes holding up, consumer confidence higher in March, solid payrolls growth, and a low unemployment rate in the backdrop, Bill Adams, chief economist at Comerica Bank, said in a note.

However, "that hike is not a sure thing, and influential voices at the Fed like Chicago President Goolsbee are laying out the justification for a pause," he said. But a May increase "will probably be the last hike of the cycle, as anticipated in the Fed's March dot plot."