Dollar rallies at euro's expense, but outlook still bleak

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The dollar rose on Tuesday, rebounding from a nearly three-month low in the previous session amid expectations of a pause in the U.S. rate hike cycle, as investors focused on the risk of a euro zone recession after data showed more signs of slowing in the region.

An unexpected fall in German industrial output for the third straight month helped to weaken the euro. The drop was modest, but it underscored concerns about a slowdown and the European Central Bank's caution as it tries to wean the region off stimulus. German exporters are struggling with weaker global demand and trade disputes driven by U.S. President Donald Trump's policies.

"The euro had its upturn halted by German data showing the third decline in as many months in a gauge of factory growth," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington. "Another decline in the fourth quarter would signal recession, a scenario that would jeopardize an ECB rate hike this year and likely increase headwinds on the single currency," he added.

The European Central Bank has said it plans to leave rates unchanged through the summer of 2019. In mid-morning trading, the euro fell 0.24 percent to $1.1447. It has traded in a tight range of $1.12 to $1.15 since mid-November.

Weakness in the euro supported the dollar, which rose 0.21 percent against a basket of currencies to 95.88. The dollar index has lost around 2 percent since mid-December and remains near a three-month low of 95.638 reached on Monday.

Dollar sentiment, however, has been bolstered by optimism about a possible U.S.-China trade agreement. U.S. Commerce Secretary Wilbur Ross said on Monday there was a good chance Beijing and Washington would reach a trade deal that "we could live with."

Against the , the dollar was little changed at 108.59 yen. Federal Reserve Chairman Jerome Powell said on Friday the Fed is not on a preset path of rate hikes and will be sensitive to the downside risks markets are pricing in. The prospect of no further rate increases is likely to keep the dollar under pressure, analysts said. Still, the lack of a compelling alternative to the greenback has helped slow currency moves to the downside, Western Union's Manimbo said.

The British pound traded down 0.49 percent at $1.2716 and traders expect the currency to remain volatile over the next few weeks. British Prime Minister Theresa May must win a vote in Parliament next week to approve her government's Brexit agreement or risk seeing Britain's exit from the European Union descend into chaos.