By Laura Matthews
(Reuters) -The dollar weakened against the euro on Tuesday but stayed near its highest level in more than two years as cooler-than-expected inflation data following last week's strong jobs report made it hard to project the Federal Reserve's next moves on interest rates.
Data showed U.S. producer prices increased moderately in December. Investors had already started to scale back bets on rate cuts as potential U.S. tariffs remained in the spotlight.
The greenback pared gains later in the session as traders cautiously awaited Wednesday's consumer price index report. Investors have been closely watching economic data to see if it supports the Fed's cautious stance on rates.
"It's possible that traders are hedging the other side of the market now before CPI tomorrow, so we're seeing some pre-release volatility that's keeping the dollar a touch depressed," said Helen Given, associate director of trading at Monex USA in Washington. "Tariff stories are the primary driver, it appears, for price action today."
Traders are pricing the first rate cut in September, but less than the 50 basis points the Fed projected in December.
With President-elect Donald Trump set to begin a second term next week, the focus has been on his policies that analysts expect will boost growth and price pressures.
The threat of tariffs along with fewer Fed rate cuts priced in has lifted Treasury yields and supported the greenback.
However, on Tuesday the market refocused on the chance that U.S. tariffs may be raised gradually, after a Bloomberg report suggested the U.S. could take a measured approach.
Trump's Treasury pick Scott Bessent is expected to keep a leash on U.S. deficits and use tariffs as a negotiating tool, mitigating the expected inflationary impact of the U.S. economic policy.
Brad Bechtel, global head of FX, at Jefferies, said while the CPI report is important, "all eyes (are on) Trump and the new administration."
Still, Matt Weller, head of market research at StoneX, said Wednesday's CPI reading "will ultimately be more significant for the central bank and therefore traders, who will be looking for a corresponding cool reading as a green light to buy up risk assets."
The dollar index, which measures the greenback versus six other currencies, was down 0.14% at 109.25, shy of the 26-month high of 110.17 it reached on Monday. It hit 114.78 in October 2022, its highest since 2002.
The euro was up 0.51% at $1.0297. It touched $1.0177 on Monday, its lowest level since November 2022.