October 17, 2017 / 9:08 AM / a year ago

FOREX-Dollar strengthens on talk of more hawkish Fed chair

* Dollar bounces as Treasury yields hit 9-year highs

* Yields up on report of Trump favouring potential policy hawk

* Sterling steady; traders eye CPI, Carney testimony

* Graphic: World FX rates in 2017 tmsnrt.rs/2egbfVh

By Jemima Kelly

LONDON, Oct 17 (Reuters) - The dollar strengthened to a one-week high against a basket of major currencies on Tuesday, supported by a rise in Treasury yields following a report U.S. President Donald Trump was edging towards choosing a hawk as the next head of the Federal Reserve.

U.S. 2-year Treasury yields hit their highest in almost nine years late on Monday, after a report that Trump was favouring Stanford economist John Taylor to head the Fed. They stayed close to those levels on Tuesday.

Taylor, an advocate of a rules-based approach to monetary policy, is seen as more hawkish than current Chair Janet Yellen and would therefore make a faster pace of tightening likely, boosting the dollar.

MUFG currency economist Lee Hardman, in London, said the bank would "not be surprised" to see an initial jump in the dollar of between 3 and 5 percent should Taylor be chosen.

"A potential shift in strategy towards a more rules-based approach for setting policy would be seen as less supportive for financial markets and increase the likelihood of the Fed raising rates materially more in the coming years than is currently priced in," he said.

The dollar index - which measures the greenback against a basket of six major peers - rose on the report, and on Tuesday climbed as much as a quarter of a percent to 93.527, its strongest since Oct. 10.

Trump's shortlist also includes Jerome Powell, a Fed governor; Trump's top economic adviser Gary Cohn; Yellen, whose term expires in February; and Kevin Warsh, a former Fed governor, sources have said, though investors say the chances of Warsh being selected have fallen.

Trump will meet current Yellen on Thursday as part of his search for a new candidate for her position, a source familiar with plans for the meeting said.

Knocked by a stronger dollar, the euro slipped 0.3 percent to a one-week lwo of $1.1755, having fallen almost 3 percent since hitting a 2-1/2-year high last month.

"The European Central Bank is now considered less hawkish than the market had initially thought last month, pushing German bund yields lower and in turn favouring the dollar against the euro," said Junichi Ishikawa, senior forex strategist at IG Securities in Tokyo.

The greenback was flat at 112.16 yen after rising 0.3 percent late on Monday, when it pulled away from a three-week low of 111.650.

The Australian dollar was 0.1 percent lower at $0.7858 as its rally last week to a two-week high on upbeat Chinese data lost momentum.

Sterling was steady at $1.3261, with traders awaiting UK inflation data as well as testimony from Bank of England Governor Mark Carney for potential cues.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets (Reporting by Jemima Kelly; Additional reporting by Shinichi Saoshiro in Tokyo; Editing by Matthew Mpoke Bigg)

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