Sept 2 (Reuters) - The dollar hit a two-week high on Wednesday as investors turned to the U.S. currency amid growing concerns about the economic impact of the energy shock and weighed diverging monetary policy paths across major economies.
Iran and its Arab neighbours were plunged back into war on Wednesday by the biggest exchange of fire between Tehran and Washington since July.
The greenback tends to benefit from higher oil prices because the U.S. economy is less exposed to energy shocks than many other major economies, attracting demand at the expense of currencies such as the euro and yen.
While most economists expect the European Central Bank to be near the end of its tightening cycle after next week's widely anticipated rate hike, the Federal Reserve is confronting a growing risk of having to tighten policy in 2027.
"We expect the ECB to finish its hiking cycle by the end of the year, while the Federal Reserve will likely be just beginning to raise rates," George Brown, senior economist at Schroders, said.
"That should widen rate differentials in favour of the dollar and lead to a weaker euro," he added, flagging that Schroders is positioned for a softer euro and expects the single currency to fall to $1.10 against the dollar by year-end.
However, a selloff in U.S. Treasuries driven by concerns about inflation and the country's fiscal trajectory can weigh on the dollar, as rising debt levels and persistent price pressures raise doubts about the long-term appeal of U.S. assets.
The dollar index , which measures the greenback against a basket of currencies including the yen and the euro, rose 0.20% to 99.865, its highest point since August 17. The euro was down 0.16% at $1.1575, after hitting $1.1566, its lowest since August 20.
The yield on the benchmark U.S. 10-year note rose to as high as 4.8182%, its firmest since November 2023. Japan's benchmark 10-year yield extended its rally to 3.01% on Wednesday after reaching a three-decade milestone of 3% on Tuesday.
Markets are now pricing in a 68% chance of a September Fed hike, up from around 40% a week earlier, according to CME Group's FedWatch tool.
DOLLAR HOLDS JUST BELOW 160 YEN
The Japanese yen rose 0.25% against the greenback to 159.89 per dollar, right above the psychologically important 160-per-dollar threshold, as markets weigh the Bank of Japan's rate path.
BOJ Governor Kazuo Ueda said consecutive rate hikes could be a possibility.
Kit Juckes, strategist at Societe Generale, mentioned hawkish comments from BoJ board member Hajime Takata.
"This is helping the yen, regardless of concerns about the impact of rising energy prices on the growth outlook and what this means for debt sustainability," he said.
"Tactically, the wise move may be to look for the yen to rally from here to the meeting on 18 September, but to sell it quite soon afterwards unless the underlying economic data surprise on the upside," he added.
A rare joint intervention by the U.S. and Japan at the end of July provided short-lived relief for the fragile yen, pulling it away from the 40-year low of 163.99, but the currency has since surrendered around half of the gains from the joint action.
The New Zealand dollar slumped 1.01% against the greenback to $0.5844, its lowest point since August 13, even after the country's central bank raised rates but stressed any further moves would be measured, as it warned of mounting risks to the economic outlook.
Reporting by Stefano Rebaudo; Editing by Shri Navaratnam and Jan Harvey
