The dollar rose against a basket of currencies for a third trading day running on Monday, as worries about a China-led "currency war" abated and traders focused instead on the prospect of higher U.S. interest rates. The dollar index had hit a one-month low .DXY last week after a surprise decision by the People's Bank of China to devalue the yuan threw cold water on expectations that the U.S. Federal Reserve would raise interest rates in September. But after the PBOC set the yuan slightly above its fixing rate on Friday, soothing fears that Beijing was intent on a bigger devaluation, markets have once again turned their attention to the diverging monetary policy between the world's major developed economies. Against the euro, which is expected to remain weak as the European Central Bank continues its 1 trillion euro asset-purchase program, the dollar was 0.3 percent higher at $1.1075 per euro EUR=. The dollar index was a third of a percent up at 96.833. With little in the way of major U.S. data on Monday or Tuesday, investors are focused on Wednesday, when U.S. inflation data and Fed minutes are released. "I think people are waiting to see the U.S. CPI and the Fed minutes – that will provide some direction for the dollar," said BMO Capital Markets' European head of FX strategy in London, Stephen Gallo. "If either of those are negative for U.S. rates, that will weigh on the dollar. People have the China move last week still in the back of their minds...but our view is that (the Fed is)still on course to raise rates in September or October." After data showed Japan's economy shrank in the second quarter, adding pressure on Prime Minister Shinzo Abe to step up his policy drive to lift the economy out of decades of deflation, the dollar gained 0.2 percent against the yen to trade at 124.53 yen. With emerging market currencies remaining wobbly, some analysts said the yen was being kept from falling lower by its safe-haven status. Market watchers are divided over whether the Bank of Japan will announce more policy easing in October. That could put the onus more on the government to offer more fiscal support. "The dollar/yen has tested those levels many times and failed to break through... For the moment, I suspect the dollar will go back and forth between 123 and 125," said State Street's Wakabayashi said. Data from the U.S. financial watchdog on Friday showed speculators increased their yen short positions in the week to last Tuesday to the highest level since June. That suggests many may need to buy back the yen in the future.
