OKYO, April 19 (Reuters) - The dollar strengthened on Wednesday, underpinned by climbing U.S. yields, though the pound held up better than most after British inflation stayed above 10% in March adding to pressure on the Bank of England to keep raising rates.
The dollar index, which tracks the currency against a basket of its peers was 0.47% higher at 102.19, as markets turning more sceptical about U.S. rate cuts later this year caused U.S. yields to rise.
Two-year Treasury yields , which are extremely sensitive to Fed expectations, gained nearly 9 basis points (bps) to a one-month high of 4.2692%.
"The market is pretty much resigned to a 25 bps hike at the (Federal Reserve's) May meeting, so it's more the ebb and flow of expectations about rate cuts this year that's causing U.S. bond market volatility," said Ray Attrill, head of foreign-exchange strategist at National Australia Bank.
"It's the volatility in the bond market that's driving the dollar, not the other way round."
According to the CME's Fedwatch tool's assessment of pricing data, there is around a 1/3 chance U.S. rates will be at their current level or higher after the Fed's December meeting.
The dollar was up 0.5% against the rate-sensitive Japanese yen at 134.82, having briefly poked its head above 135 for the first time in a month, while the euro slid 0.48% to $1.0922. ,
The "risk off" mood that helped the dollar could be felt across markets with European shares and U.S. share futures struggling alongside assets like non-yielding gold.
"Risk sentiment turned negative during the European morning session, with zero- and low-yielding assets taking the brunt of the sell-off as bond yields have continued to extend their recovery," said Fawad Razaqzada, market analyst at City Index.
"It looks like UK's 10%+ CPI reading was the culprit. This has revived worries that interest rates will remain high for longer in the UK – and Europe."
Wednesday data showed British consumer price inflation eased by less than expected in March to 10.1% from February's 10.4%, meaning Britain has western Europe's highest rate of consumer inflation.
The pound gave back earlier gains to trade 0.2% lower at $1.2398, outperforming other non-U.S. currencies due to expectations the Bank of England will have to raise rates more to bring down inflation.
Expectations for higher official rates in a market relative to those elsewhere typically drag money market and government bond yields higher, attracting cash into a country while boosting its currency at least in the short term.
Deutsche Bank on Wednesday, revised up expectations for British rates to include two more 25 basis point rate hikes from the Bank of England. Morgan Stanley now predict one, with a risk of a second.
The pound also strengthened a little against the euro, with the common currency down 0.2% to 88.12 pence.
Traders continue to keep a close eye on remarks by Federal Reserve policy markets about their rate hike intentions.
St. Louis Fed chief James Bullard told Reuters in an interview that he leans towards 75 bps of additional tightening, versus the market consensus for one more 25 bps hike next month and then the potential for as many as two quarter-point cuts later this year.
By contrast, Atlanta Fed President Raphael Bostic said in an interview with CNBC that he expected just one more quarter point hike, followed by an extended pause.
