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Dollar gains after US consumer prices rise more than expected.

By Herbert Lash and Alun John | Reuters |

© Reuters. FILE PHOTO: The employee of a currency exchange shop counts U.S. dollar banknotes in Ciudad Juarez, Mexico July 27, 2023. REUTERS/Jose Luis Gonzalez/File Photo

NEW YORK/LONDON (Reuters) - The dollar strengthened on Thursday after U.S. consumer prices rose more than expected in September on a still elevated cost of rent that bolstered the prospect of the Federal Reserve keeping interest rates high for some time.

The Labor Department's report on Thursday showed the annual increase in consumer prices last month, excluding the volatile food and energy components, was the smallest in two years.

But owners' equivalent rent, a measure of the amount homeowners would pay to rent or would earn from renting their property, shot up 0.6% compared to non-official sources showing a decline in rental prices.

"People who know about this divergence don't worry too much about this number," said Thierry Wizman, Macquarie’s global FX and interest rates strategist in New York.

"Since the Fed makes its decisions based on the official numbers, not on what third party sources are showing, it's a little bit worrisome" though eventually they converge, he said. The dollar index rose 0.615% to 106.310, while the euro declined 0.63% to $1.055.

"Even though September was a blip, I don't think that it negates the overall picture of the declining inflation. I don't think that this is going to cause (the Fed) to hike," Wizman said. "The only thing that the market is missing is that somehow it thinks that the Fed is going to drop high for long."

The dollar's recent weakness has been driven by declining Treasury yields as bond prices rallied on the Fed's softer stance on future rate rises. Bond yields move opposite to their price.

The yield on 10-year Treasuries rose 4.2 basis points (bps) to 4.6388%. The benchmark note hit its highest since 2007 last week at 4.887% but is down roughly 25 bps this week.

Also in the mix for currency investors on Thursday were sluggish British growth figures, which showed the economy partially recovered in August after a sharp drop in July.

The pound initially did not significantly react but later fell 0.65% to $1.2232. The pound was the best performing G10 currency in the first half of this year, thanks to better-than-expected economic data and sticky inflation that drove expectations the Bank of England (BoE) would be increasing rates for longer than most peers.

It then had its worst month in a year in September, as those factors reversed, before steadying this month.

"Without a growth pickup, inflation is likely to continue cooling back towards the BoE’s target, and a final rate hike this year looks risky given current economic weakness," said Nick Rees, FX market analyst at Monex Europe.

"FX markets appear of a similar view."

Thursday's CPI release came after Wednesday's mixed report on U.S. producer prices, and minutes from the Fed's September meeting. Fed officials pointed to uncertainties around the economy, oil prices and financial markets as supporting "the case for proceeding carefully in determining the extent of additional policy firming that may be appropriate", the minutes showed.

The Swiss franc had been set to strengthen for the seventh successive session, the longest streak since July 2020. But the franc retreated, with the dollar up 0.39% at 0.9054.

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