Dollar holds firm as US-Iran tensions lift oil, hawkish Fed bets build

By Jiaxing Li

HONG KONG, Sept 28 (Reuters) - The dollar was on the defensive on Monday but remained near a two-month high, as the US-Iran standoff continued to push up oil prices and bond yields, while investors looked ahead to a data-packed week for further clues on inflation and central-bank policy.

The euro was a shade weaker at $1.1386, hovering near two-month lows against the greenback and on course for a 2% decline in September.

Sterling held steady at $1.3247, close to a three-month low, after Bank of England Governor Andrew Bailey reiterated a rate hike warning.

The dollar index , which measures the US currency against a basket of peers, eased slightly to 101.12 but was still set for a 1.7% gain this month, its best gain since June.

Oil prices climbed more than 3% on Monday with Brent crude futures last above $107 a barrel, after US President Donald Trump rejected a peace deal with Iran to resolve their conflict and reopen the Strait of Hormuz.

Energy supply risks and robust fundamentals in the US have heightened inflation concerns and prompted traders to price in a more hawkish Federal Reserve, while a relentless rise in long-end Treasury yields also supported the dollar.

"The greenback could overshoot in the near term if energy market tensions persist and inflation risks continue to build," said Sim Moh Siong, FX strategist at OCBC.

The bank's base case remains for a moderate dollar rally into year-end, he added.

The market's focus is set to turn to US data releases as the week unfolds, with the PCE Index USPCEM=ECI on Wednesday and non-farm payrolls USNFAR=ECI on Friday both expected to be consistent with further policy tightening.

Currently, markets are seeing a 65% chance of a rate hike from the Fed when the central bank meets next at the end of October, according to CME Group's FedWatch tool.

Other data for the week include China PMIs CNPMIB=ECI on Wednesday ahead of the week-long National Day holidays and euro zone CPIs EUHICF=ECI on Friday.

The yen was last down 0.3% at 157.7 per dollar, trimming gains from Friday, after Japan's Finance Minister Satsuki Katayama and US Treasury Secretary Scott Bessent reaffirmed that the two nations intend to strengthen cooperation to address yen weakness.

Meanwhile, data on Monday showed Japan's service-sector inflation rose in August at the fastest annual pace in more than two years, highlighting mounting price pressures and bolstering the case for faster rate hikes from the Bank of Japan.

The Australian dollar fetched $0.70125 and the kiwi strengthened 0.1% to $0.5670 .

The Reserve Bank of Australia is expected to raise interest rates by 25 basis points to a near 15-year high of 4.60% on Tuesday, likely the final rate increase in the tightening cycle.

Elsewhere, offshore yuan strengthened slightly to 6.714 per dollar, after Trump and Chinese President Xi Jinping's three-day summit did not yield any big public breakthroughs on a host of contentious issues.