Dollar Extends Pullback but Remains on Track for Weekly Gain as Fed Rate Expectations Hold

The U.S. dollar weakened for a second consecutive session on Friday as softer inflation data and a sharp decline in oil prices eased expectations of additional Federal Reserve interest rate hikes, although the currency remained on course for a weekly advance.

Despite the recent retreat, the greenback is still posting gains for the week and is set to record its strongest monthly performance since March after climbing to a 13-month high earlier this week.

Market sentiment shifted after fresh U.S. inflation figures released on Thursday broadly matched economists' expectations, while a steep drop in crude oil prices further reduced concerns that energy-driven inflation would force the Federal Reserve to tighten monetary policy more aggressively.

Even so, data from the London Stock Exchange Group indicated that financial markets continue to price in roughly one additional 25-basis-point interest rate increase before the end of the year.

The dollar's rally had gathered momentum earlier in the week following the Federal Reserve's first policy statement under Chair Kevin Warsh, which investors interpreted as signaling a more hawkish approach to inflation.

Joseph Trevisani, senior analyst at FX Street in New York, said the latest decline reflects a natural pause after months of sustained gains.

"The dollar has been in a strong upward trend since January, supported not only by policy expectations but also by improving economic data," Trevisani said. "A modest pullback after such a rally is hardly surprising."

Meanwhile, the University of Michigan's final consumer sentiment survey showed confidence improving to 49.5 in June from 44.8 in May. Although the reading fell slightly short of economists' expectations of 50.0, it suggested households are becoming somewhat more optimistic despite persistent inflation concerns.

The U.S. Dollar Index, which measures the currency against a basket of six major peers, fell 0.39% to 101.11, marking its largest two-day decline since early May. The euro climbed 0.43% to $1.1418, while sterling gained 0.24% to $1.3223, although the British currency remained on track for a second consecutive weekly loss.

Oil prices also weighed on the dollar's outlook. U.S. West Texas Intermediate crude fell 3.81% to $69.18 per barrel, while Brent crude dropped 4.17% to $72.12. Both benchmarks were heading for weekly declines of nearly 10% as energy shipments through the Strait of Hormuz continued to recover.

The Japanese yen remained under close market scrutiny, trading at 161.59 per dollar after strengthening modestly during the session. Traders remain alert to the possibility of intervention by Japanese authorities should the currency weaken further toward levels not seen since 1986.

Supporting the yen, fresh data showed Tokyo's core inflation accelerated in June, reinforcing expectations that the Bank of Japan could maintain a gradual path toward policy normalization even as global markets continue to focus on the Federal Reserve's next move.