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Dollar Up vs. Euro, Down vs. Yen as Fed Holds

The dollar edged higher against the euro but a touch lower versus the yen Tuesday, after the Federal Reserve kept U.S. interest rates steady as expected, and inflation remained its primary concern.

The euro slipped 0.3 percent against the dollar at $1.3746, from $1.3755 before the Fed decision. Against the yen, the dollar was slightly down at 118.66 yen.

In a statement, the Fed also acknowledged the ongoing volatility in the U.S. credit sector and correction in the U.S. housing market, but added that the economy was likely to expand at a moderate pace in the coming quarters.

Investors viewed the Fed's statement as an indication that it will hold off cutting interest rates, effectively preserving the greenback's yield advantage over other major currencies.

The Fed said a moderation in U.S. core inflation was still not evident.

"The statement is not as dovish as some participants hoped for, and the dollar has strengthened modestly in the immediate aftermath," said Marc Chandler, global head of FX strategy at Brown Brothers Harriman in New York.

Against the Swiss franc, the dollar rose 0.4 percent to 1.1962 francs. The British pound, meanwhile, fell 0.4 percent to $2.0230.

The yen had briefly rallied against major currencies on the Fed's inflation remarks, tracking initial falls in the U.S. stock market, but came off highs as equities rebounded.

In recent weeks, the yen has maintained a tight negative correlation with U.S. stock prices. When stock prices are falling, investors tend to buy back the yen to unwind investments in risky carry trades, in which purchases of higher-yielding currencies are financed by borrowing cheaply in the Japanese currency.

U.S. equities closed higher, with investors heartened by the Fed statement that it is keeping an eye on credit markets, although future policy would still depend on the outlook for inflation and growth.

The implied chances for a rate cut at the next Federal Open Market Committee meeting in September fell to 20 percent from 46 percent Monday.

Prospects for an October cut dropped to 52 percent from 84 percent. An October ease was fully priced as recently as Friday but has retreated in step with a higher stock market.

Futures prices still imply one quarter-percentage-point Fed rate cut by year-end and two by mid-2008.

Some analysts said that while inflation remained a focus of the Fed, it could move to a more neutral stance at the September meeting.

"While the Fed chose to retain its inflation bias, it may very well decide to move to a neutral bias at its next meeting if upcoming data confirm that core inflation has moved back to the preferred 1-2 percent range," said Michael Woolfolk, senior currency strategist at Bank of New York Mellon.

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