FOREX-Dollar fails to catch a lift from higher yields, Bank of Japan in focus

By Alun John

HONG KONG, Jan 18 (Reuters) - The yen edged higher ahead of the outcome of a central bank policy meeting on Tuesday, while the dollar seemingly ignored U.S. Treasury yields hitting new near two-year highs on their return from a long weekend break.

The Bank of Japan will probably slightly revise up its inflation forecast in a quarterly outlook report after the meeting, due to rising energy costs, Reuters reported last week citing sources, though the new projection will still be below the BOJ's 2% target.

The meeting is expected to wrap up by late morning in Tokyo.

The dollar slipped as much as 0.15% against the yen in early trading to 114.43 yen per dollar, and was also slightly softer versus the pound and euro.

The weakness in the dollar came even as U.S. Treasury yields continued to gain, with the short end of the curve hitting new pandemic highs, which would normally be supportive for the greenback.

Two-year yields rose above 1% for the first time since February 2020 at the open in Asia, as trading returned after a U.S. holiday, and five-year yields rose 3.6 bps to 1.5960%, the highest since January 2020.

Yields have been rising this year, with traders expecting the Federal Reserve to begin hiking interest rates as soon as March, but the dollar index, which measures the greenback against six peers has lost 0.52% year to date.

"The conundrum everyone is grappling with is either the dollar is a screaming buy relative to yields, or there is a lot of dollar supportive news priced in," say Ray Attrill head of FX strategy at National Australia Bank.

He said theories for the anomaly included investors reacting early to the fact the dollar has historically peaked around the time the Fed has raised rates, or they were trading in anticipation of a surge in global economic growth. But he said he was not convinced by either argument.

The euro was on the front foot at $1.1416, while sterling was steady at $1.3657, after an early rally in both currencies at the start of the year petered out late last week.

As the pound has been boosted by aggressive Bank of England tightening expectations, analysts at ING said they thought any weakness due to political uncertainty in Britain where Prime Minister Boris Johnson is facing calls to resign, would be contained.

There is no major economic data for the euro zone on the calendar this week, but investors will focus on speeches from European Central Bank President Christine Lagarde, other ECB members and on the minutes of the central bank's December policy meeting on Thursday.

The Aussie dollar (AUD=D3> was steady at $0.722.

Bitcoin was in the doldrums at $42,353, having been trending downwards since hitting its record high of $69,000 in November.

(Reporting by Alun John; Editing by Kim Coghill and Jacqueline Wong)