TOKYO - The dollar traded near a 2 1/2-week high to major peers on Monday as quickening inflation in the United States boosted the case for earlier Federal Reserve interest rate hikes ahead of a policy decision on Tuesday.

The greenback approached a 1 1/2-week top to the yen. The safe-haven Japanese currency weakened after a strong showing for the ruling party in weekend elections eased doubts about the new prime minister's popularity. 

The dollar index, which measures the U.S. currency against six rivals, was little changed at 94.161, hovering close to Friday's peak of 94.302, a level not seen since Oct. 13.

The U.S. currency traded 0.16% stronger at 114.205 yen, reaching as high as 114.315. Above 114.41 would be the strongest since Oct. 20, when it hit an almost four-year high of 114.695.

Japanese Prime Minister Fumio Kishida's ruling Liberal Democratic Party defied expectations and held its strong majority in Sunday's parliamentary election, solidifying his position in a fractious party and allowing him to ramp up stimulus.

"The reduction in political uncertainty is playing out with slight yen weakness this morning," said Shinichiro Kadota, senior FX strategist at Barclays in Tokyo.

"The bigger driver of dollar-yen direction going ahead remains the Fed."

Monetary policy in the United States and elsewhere is in sharp focus this week, with the Federal Open Market Committee widely expected to announce a tapering of stimulus.

A 4.4% surge in the government's index of core personal consumption expenditures - the Fed's preferred inflation measure - solidified market expectations for a rates lift-off around the middle of next year. 

Following the data, futures on the fed funds rate 0#FF: , which track short-term rate expectations, priced in a 90% chance of quarter-point tightening by June 2022, factoring in another rate increase by December.

Those bets could be shaken again this Friday, with the release of the closely watched monthly payrolls report.

The dollar "looks well-positioned to build on gains through a potentially decisive week of event risk," Westpac strategists wrote in a note to clients, predicting a "brisk" $15 billion per month tapering of asset purchases and a jobs number "at least as strong as consensus."

Any dips in the dollar index to the mid-93 level are a buying opportunity, they said.

The Reserve Bank of Australia also decides policy on Tuesday, with markets challenging the central bank's contention that rates won't rise until 2024.

"There is a chance the guidance for hiking in 2024 will change to 2023," Chris Weston, head of research at brokerage Pepperstone in Melbourne, wrote in a client note.

"There is a strong chance the statement attempts to push back on rate hikes which have gone so hard – effectively pricing the first hike by May 2022 and two hikes by July."

The Aussie dollar slipped 0.13% to $0.7511, continuing its retreat from a nearly four-month high $0.75555 reached last week.

The Bank of England announces its policy decision on Thursday, with markets weighing whether the monetary authority will raise rates at the meeting.

Sterling was mostly flat at $1.3680, and earlier dipped to $1.3663 for the first time since mid-October.

Meanwhile, the euro was about flat at $1.15605, staying close to Friday's low of $1.1535, the weakest since Oct. 13.

 

(Reporting by Kevin Buckland; editing by Richard Pullin and Ana Nicolaci da Costa) ((Kevin.Buckland@thomsonreuters.com;))