By Peter Nurse

Investing.com - The U.S. dollar edged lower in early European trading Tuesday, but remained near a 20-year high as the market geared up for another aggressive rate increase by the Federal Reserve.

At 02:50 ET (06:50 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.1% lower at 109.297, still close to the two-decade peak of 110.79 reached on Sept. 7.

The U.S. Federal Reserve starts its latest two-day policy-setting meeting later this session, and is set to continue its policy of super-sized interest rate hikes to try and rein in overheated inflation.

An increase of 75 basis points is widely expected, but some investors are bracing for a full percentage point hike as last week’s consumer price index showed inflation remaining stubbornly high.

The decision will be accompanied by a fresh set of projections on inflation, economic growth and the future path of interest rates, which will be studied very closely for guidance towards the central bank’s terminal or peak rate.

“After the recent development in the U.S. economy and inflation, we now expect the FOMC to front-load rate hikes and to reach its peak earlier. We expect the fed funds (upper) rate to peak at 4% in December instead of February,” said analysts at ABN Amro, in a note.

EUR/USD rose 0.1% to 1.0035, strengthening its position above parity after German producer prices rose in August at their strongest rate since records began, climbing 45.8% on the same month last year, with soaring energy prices continuing to act as a main driver.

The European Central Bank raised interest rates by 75 basis points last week as the policymakers attempted to tackle inflation nearing double digits. This news from the Eurozone’s largest economy can only strengthen their resolve.

USD/JPY rose 0.1% to 143.32, with the yen further weighed by the United States 2-Year Treasury yield climbing as high as 3.970% overnight for the first time since November 2007.

The Bank of Japan holds a policy meeting on Thursday, but is widely expected to keep its ultra-easy stimulus settings unchanged.

This difference in stance between the Fed and the BOJ is weighing heavily on the yen, with the pair climbing as high as 144.99 in early September for the first time in 24 years.

GBP/USD rose 0.1% to 1.1442, with sterling recovering to a degree after a drop to a 37-year low of 1.1351 at the end of last week.

The Bank of England will also decide policy on Thursday, and another interest rate hike is expected, either of 50 or 75 basis points.

USD/CNY rose 0.1% to 7.0128, remaining above the psychologically-important 7 level with the Chinese authorities having to strike a delicate balance between loosening monetary policy to support a weakening economy and preventing further losses in the currency.