Dollar driven to five-week high by Fed rate hike forecasts

NEW YORK, Aug 19 (Reuters) - The U.S. dollar index hit a five-week high and posted its biggest weekly gain since April 2020 on Friday as investors adjusted for the likelihood that the Federal Reserve will keep hiking rates to battle inflation.

The U.S. central bank needs to keep raising borrowing costs to tame decades-high inflation, a string of its officials said on Thursday, even as they debated how fast and how high to lift them. read more

"They still have their work cut out for them and I don't think the market was really positioned that way after the July FOMC," said Bipan Rai, North American head of FX strategy at CIBC Capital Markets in Toronto, referring to the Fed's Federal Open Market Committee meeting. "It's really all about getting inflation back to target."

The dollar index rose 0.61% to 108.13, its highest since July 15, while the euro dropped 0.54% to $1.0033, its lowest since the same date.

The greenback gained 0.73% to 136.87 against the Japanese yen , the strongest since July 27. Sterling tumbled 1.03% to $1.1813 and had its biggest weekly drop against the dollar since September 2020.

The Fed is seen as having more room to hike rates than central banks of other large economies which are more fragile.

"For the USD to weaken meaningfully, the Fed has to get more concerned about growth than inflation, and we are not there yet," Bank of America analyst Michalis Rousakis said in a report on Friday.

"Meanwhile, we expect the (European Central Bank) to stop hiking next year on concerns around growth and/or spreads. EUR is also exposed to the much worsened terms of trade and the slowdown in China," Rousakis said.

The euro was also dented on Friday after Gazprom said the Nord Stream 1 pipeline, which supplies gas from Russia to Europe under the Baltic Sea, will be shut down from Aug. 31 to Sept. 2 for maintenance. read more

Fed funds futures traders are pricing in a 55% expectation that the Fed will hike rates by 50 basis points in September and a 45% probability of a 75 basis points increase.

U.S. central bank officials have "a lot of time still" before they need to decide how large an interest rate increase to approve at their Sept. 20-21 policy meeting, Richmond Fed President Thomas Barkin said on Friday. read more

Fed Chair Jerome Powell will update the market on his views at the annual Jackson Hole symposium on Aug. 25-27.

China's yuan slipped to its lowest since September 2020 at 6.8199 per dollar in onshore trading after the central bank set a much-weakened midpoint guidance, with traders expecting further downside.

In cryptocurrencies, bitcoin fell 8.73% to $21,188. Ether was down 8.34% to $1,693.

"Weakness has seeped into the crypto sphere as speculators retreated from highly risky assets," said Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown.

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Currency bid prices at 3:00PM (1900 GMT)