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Dollar Drifts Ahead of Fed Meeting; Australian Dollar Slumps

The dollar stabilized in early European trading Tuesday ahead of the start of the latest Federal Reserve meeting, while the Australian dollar weakened sharply after the country’s central bank tightened monetary policy less than many had expected.

At 3 AM ET (0800 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded marginally lower at 93.843, after retreating Monday from a 2 1/2-week high of 94.313.

Elsewhere, AUD/USD fell 0.7% to 0.7470 after the Reserve Bank of Australia surprised the market by not raising its key rate from 0.1%, stressing that inflation was still too low to hike in the near term.

However, the RBA did drop its policy of yield curve control, saying it would no longer try to cap three-year government bond yields. It also removed its previous projection that rates were unlikely to rise until 2024, but traders had been expecting a more aggressive stance given the strong domestic inflationary pressures.

Now attention turns to the latest Federal Reserve policy-setting meeting, with the two-day gathering set to start later Tuesday.

The U.S. central bank is widely expected to announce a tapering of stimulus, especially after a record quarterly increase in Friday’s employment cost index illustrated the degree of current inflationary pressure.

“This measure had been a preferred one for the Greenspan Fed in the 1990s and a surging figure will no doubt be unnerving some core members of the FOMC," said analysts at ING, in a note. "We think this will add to the case for a confident tapering announcement from the Fed on Wednesday.”

A survey by Bloomberg points to the Fed checking the current $120 billion monthly buying pace by reducing Treasury purchases by $10 billion a month and mortgage-backed security purchases by $5 billion a month.

The economists surveyed are more divided over when the central bank will start hiking interest rates, with a small majority suggesting early 2023 rather than in 2022.

Additionally, USD/JPY traded 0.3% lower at 113.65, continuing to consolidate below an almost four-year peak of 114.69 reached on Oct. 20, while EUR/USD edged higher to 1.1610.

GBP/USD edged lower to 1.3667 ahead of a Bank of England meeting on Thursday, with the central bank potentially set to lift its interest rates for the first time in years.

Inflation in Britain looks set to rise to 5%, more than double the BoE's 2% target, but the country’s economic recovery from last year's slump looks like it’s slowing as the government withdraws key support programs for households and businesses.

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