May 2, 2018 / 8:01 AM / 3 months ago

CORRECTED-FOREX-Dollar break above key level prompts investor rethink

(Corrects to say Wednesday in the lead, not Friday)

* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh

LONDON, May 2 (Reuters) - The dollar consolidated gains on Wednesday after hitting a 3-1/2 month high in the previous session as investors waited for the outcome of a U.S. Federal Reserve policy meeting where policymakers may outline the future outlook on interest rates.

Though financial markets don't expect any change in U.S. monetary policy, investors will look for any comments that take into account the impact of a stronger dollar and higher yields on monetary policy with any evidence of increased caution likely to stop the dollar's rally in its tracks.

"Despite the moves we have seen in the dollar in recent days, financial conditions haven't really tightened noticeably but that may change if the rally continues," said Manuel Oliveri, an FX strategist at Credit Agricole in London.

Against a basket of its rivals, the dollar has surged past its 200-day moving average on Tuesday, a level it hasn't traded above since May 2017, a level which typically attracts some reassessment from large institutional investors on their dollar positions, according to Morgan Stanley.

On Wednesday, it was trading 0.2 percent lower at 92.242 after hitting a Jan. 10 high of 92.57 in the previous session.

While the Federal Reserve is widely expected to keep the benchmark interest rate on hold at its policy meeting ending on Wednesday, it looks certain to raise borrowing costs next month, given signs of possible acceleration in the U.S. economy and possibly two more times over the remainder of the year.

The Institute for Supply Management (ISM) survey published on Tuesday showed U.S. factory activity slowed in April, but it highlighted shortages of skilled workers and rising costs, suggesting inflationary pressure is building.

"We are seeing a roll-back of dollar selling since the start of the year. If the upcoming U.S. jobs data shows gains in wage rises, that would propel the dollar higher," said Shinichiro Kadota, senior currency strategist at Barclays Capital in Tokyo.

Elsewhere, the euro received some reprieve after posting its biggest weekly loss in more than two months last week with investors squaring positions before the Q1 GDP data due later in the day.

Economists polled by Reuters said they thought the euro zone economy grew 2.5 percent year-on-year in the first three months of 2018, compared with a 2.7 percent increase in the previous quarter.

Sterling trod water after falling through the $1.36 line in the previous session as investors further reduced bets of a central bank rate hike next week.

The British pound edged 0.2 percent higher at $1.3635 after having fallen to a four-month low of $1.3588 on Tuesday on soft UK manufacturing data.

Other currencies which have borne the brunt of the dollar's rally in the last two weeks such as the Australian dollar, Canadian dollar and the Swiss franc stabilised on Wednesday, rising between 0.2 to 0.4 percent. (Reporting by Saikat Chatterjee Editing by Andrew Heavens)

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