FOREX-Dollar inches up, set for largest weekly gain in two months on Fed rate hike bets

* Inflationary pressures fuel rate hike expectations

* Trump-Xi summit gives markets little to cheer

* Yen struggles at 158 level; turmoil weighs on sterling (Updates for early European afternoon trading)

By Samuel Indyk and Rae Wee

LONDON, May 15 (Reuters) - The dollar was a touch higher and heading for its biggest weekly gain in more than two months, as mounting inflationary pressures from higher energy prices fuelled bets on a Federal Reserve rate hike this year.

The dollar's climb on Friday came alongside rising U.S. Treasury yields that have jumped to one-year peaks as traders ramped up bets that the Fed would need to raise rates this year.

The U.S. dollar's rally has been gathering pace all week on evidence that while domestic inflation is mounting, the U.S. economy remains resilient despite the ongoing Middle East conflict.

"The dollar is catching up with the strong data we've seen this week," ING FX strategist Francesco Pesole said.

"It feels like there's a realisation that the U.S. story in an energy crisis may just end up being much better than many other places in the world."

Data on Thursday showed U.S. retail sales increased further in April while weekly initial jobless claims figures pointed to stability in the labour market.

Investors are now pricing in a more than 55% chance that the Fed could raise rates by December, compared with less than a 20% chance a week ago, according to the CME FedWatch tool.

Against a basket of currencies, the dollar rose to a more than one-month high of 99.29, before edging back slightly. It was still up 1.2% on the week, its steepest weekly rise since early March.

The euro fell to a one-month low of $1.1617, before bouncing slightly. It was set to lose 1.1% for the week.

The yen was little changed on the weaker side of 158 per dollar despite domestic data pointing to a spike in wholesale inflation, bolstering the case for the Bank of Japan to raise interest rates as soon as June.

Sterling touched its weakest in five weeks against the dollar and was on course for its biggest weekly fall since November 2024 as Prime Minister Keir Starmer battled to hold on to power after disastrous local election results last week.

Markets are concerned that a new leader, such as Greater Manchester Mayor Andy Burnham or former deputy PM Angela Rayner, may prefer looser fiscal policy.

The pound was last down 0.2% at $1.3378, and 1.9% on the week, its biggest weekly drop since November 2024.

"If you look at the move (in the pound) in the past 24 hours or so, it's roughly 50% dollar driven and 50% sterling driven," ING's Pesole said.

"The concern for gilts and the pound was mostly surrounding Andy Burnham. If he enters a leadership challenge then the pound will remain under pressure until he clarifies his fiscal position in a more market-friendly fashion."

TRUMP-XI SUMMIT

Markets, meanwhile, hardly reacted to a closely watched two-day summit between U.S. President Donald Trump and his Chinese counterpart Xi Jinping that concluded on Friday. Beijing warned Washington against mishandling Taiwan and said the Iran war should never have started.

The onshore yuan retreated from its highest level against the dollar in more than three years due to broad dollar strength and was last at 6.8021. Its offshore counterpart dipped 0.3% to 6.8067.

Trump said his patience with Iran was running out, and that he and Xi do not want Iran to have nuclear weapons and "want the straits open".

Iranian Foreign Minister Abbas Araqchi said on Friday Tehran had received messages from the United States seeking continued talks, but the Islamic Republic would only negotiate if the U.S. was serious. (Reporting by Samuel Indyk and Rae Wee; Editing by Kate Mayberry, Jamie Freed, Ros Russell and Andrew Heavens)