FOREX-Dollar staggers to third weekly decline as investors ponder Fed outlook

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Euro and sterling rise as dollar weakens

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Fed's less hawkish stance drags dollar

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Markets diverge from policymakers on rate cuts for next year

(Updates to Asia afternoon)

By Ankur Banerjee

SINGAPORE, Dec 12 (Reuters) - The U.S. dollar headed for its third straight weekly drop on Friday, hurt by the prospect of rate cuts next year after the Federal Reserve pushed back against hawkish market bets, lifting the euro and sterling to their highest since October.

The euro last bought $1.1738 after a 0.37% rise in the previous session, while the pound was firmer at $1.3395. Both are poised for their third-straight week of gains as the dollar remains under pressure.

The Fed cut rates as expected this week but the comments from Fed Chair Jerome Powell and the accompanying statement were viewed by investors as less hawkish than expected and reinforced dollar-selling momentum.

"We judge that concerns around the U.S. labour market will be one factor driving the FOMC to cut interest rates further next year," said Kristina Clifton, senior currency strategist at Commonwealth Bank of Australia. "We expect three cuts in 2026 taking the funds rate to 2.75% to 3.0%."

Investors face uncertainty over the path of U.S. monetary policy next year as inflation trends and labour market strength remain unclear, with traders pricing in two rate cuts in 2026 in contrast with policymakers who see only one cut next year and one in 2027.

Kieran Williams, head of Asia FX at InTouch Capital Markets, said there was a firm basis for markets to doubt the Fed's "higher-for-longer" dot plot, as historical data shows the Fed chases the two-year Treasury yield as opposed to the other way around.

"If growth data continues to soften the Fed will be forced to migrate towards the market's more dovish pricing, which could further weigh on (the) dollar."

How monetary policy evolves from here will hinge on economic data that is still lagging from the impact of the 43-day federal government shutdown in October and November. This comes as the U.S. heads into a midterm-election year that is likely to focus on economic performance, with President Donald Trump urging sharper rate reductions.

Also in the spotlight for markets is the question of who will become the next Fed chair and how that will affect the growing worries about the central bank's independence under Trump.

The dollar index, which measures the U.S. currency against six major rivals, was at 98.36, set for a weekly drop of 0.7%. The index is down more than 9% this year, on pace for its steepest annual drop since 2017.

The Japanese yen was slightly weaker at 155.76 per dollar ahead of next week's Bank of Japan meeting where the broad expectation is of a rate hike. Market focus is on comments from the policymakers on how the Japanese rate path will look in 2026.

The Australian dollar was steady at $0.6667 and the New Zealand dollar 0.14% firmer at $0.5815 as investors contend with diverging rate paths, with the next move in domestic interest rates likely to be up, even as U.S. rates are expected to keep falling.

Elsewhere, the Swiss franc strengthened to 0.7942 per U.S. dollar in Asian hours after a strong session overnight. The Swiss National Bank left its policy rate unchanged at 0% on Thursday and said a recent agreement to reduce U.S. tariffs on Swiss goods had improved the economic outlook, even as inflation has somewhat undershot expectations.

The dollar weakness also lifted currencies in emerging markets, with the Malaysian ringgit firming to a four-year peak. (Reporting by Ankur Banerjee in Singapore; Editing by Shri Navaratnam and Jamie Freed)