SYDNEY - The dollar held firm on Wednesday after the previous day's surge in U.S. yields resulted in sharp gains against the euro and put the greenback above support levels established in recent months amid mounting expectations for U.S. interest rate increases.

The euro is back on its 50-day moving average at $1.1327 after falling about 0.7% on Tuesday, its sharpest daily drop in a month.

The greenback also held sterling below its 200-day moving average ahead of British inflation figures due later Wednesday, as talk of a leadership challenge to Prime Minister Boris Johnson added uncertainty. 

Annual headline inflation in Britain is seen hitting an almost decade-high 5.2% and a surprise could trigger further bets on Bank of England rate hikes and renew the pound's rally.

The dollar has been boosted by U.S. Treasury yields rising further ahead of next week's Federal Reserve policy meeting at which traders are starting to fear another hawkish surprise.

"A lot of (Fed) officials left us with hawkish impressions right before going quiet (ahead of the meeting)," NatWest markets' strategist Jan Nevrusi said.

"After (Tuesday's) price action, there is slightly more than one hike priced in for the March meeting, and going into next week, I would imagine it oscillates within the lower end of the 25-50 basis point range."

Two-year Treasury yields have leapt 15 basis points over two sessions to cross 1% and benchmark 10-year yields inched up on Wednesday to touch a new two-year high of 1.9%. 

Fed funds futures 0#FF: are pricing three more hikes in 2022. Analysts say dollar strength could extend if traders start expecting rates to rise not just faster but further as well.

"We expect the U.S. rate rethink - and this latest shift higher in yields reflects a push higher in the implied terminal rate, rather than just a faster pace of increases initially - to support the dollar in the first half of the year," Societe Generale strategist Kit Juckes said.

Moves in the U.S. bond market unsettled equity investors, providing some support on Wednesday to the safe-haven yen, which was at 114.41 to the dollar, slightly firmer on the day.

The overall result was that the U.S. dollar index held onto most of its 0.5% gain Tuesday, to trade at 95.676.

Traders also kept a wary eye on a delicate situation in Ukraine. U.S. Secretary of State Antony Blinken will seek to defuse a crisis with Moscow when he meets Russia's foreign minister in Geneva this week. 

The Australian dollar was at $0.7192, still struggling to break resistance just below 73 cents. The kiwi was pinned at $0.6787.

 

(Reporting by Tom Westbrook; additional reporting by Alun John, Editing by Himani Sarkar & Simon Cameron-Moore) ((tom.westbrook@tr.com; +65 6973 8284;))