FOREX-Dollar slips as US inflation data keeps rate hike at bay

(Updates to U.S. afternoon)

* US consumer prices increase as expected in May

* U.S.-Iran tensions keep traders guessing

* Yen remains weak despite expected BOJ rate hike

By Saqib Iqbal Ahmed

NEW YORK, June 10 (Reuters) - The dollar slipped on Wednesday after data showed U.S. consumer inflation rose to its highest level in three years in May, though the reading was in line with economists' expectations, doing little to raise the chances of a Federal Reserve rate hike this year. U.S. consumer inflation increased at its fastest pace in three years in May as the Iran war raised the price of gasoline and other energy products.

The Consumer Price Index increased 4.2% in the 12 months through May, the largest gain since April 2023, the Labor Department's Bureau of Labor Statistics said on Wednesday. Economists polled by Reuters had forecast the CPI increasing 4.2% year-on-year.

"Underlying inflation avoided a widely feared acceleration last month, suggesting that soaring energy prices are not yet feeding into the core measures targeted by the Federal Reserve," said Karl Schamotta, chief market strategist at Corpay in ?Toronto.

The dollar index, which measures the U.S. currency against six peers, was 0.1% lower at 99.875, not far from the two-month high of 100.214 touched on Monday.

"Traders are positioning for a more neutral statement from officials at next week's (Federal Open Market Committee) meeting, and are modestly lowering expectations for a rate hike by year-end," Schamotta said.

Traders of short-term U.S. interest rates edged away from bets that the Federal Reserve will deliver a rate hike as soon as September, but continued to show strong conviction that a rate hike would arrive by October. The Fed will hold its key interest rate for the rest of 2026, according to a strong majority of economists in a Reuters poll.

"After three months of elevated energy costs, meaningful pass-through to core goods has not materialized," Jason Pride, chief of investment strategy and research at wealth management firm Glenmede, said in a note. "This represents the clearest data point in today's report that the Iran shock, however large at the pump, has not metastasized into a generalized inflation episode."

Still, the war kept traders on edge.

U.S. President Donald Trump said on Wednesday that the United States will attack Iran "very hard" if no peace deal is secured, and announced the U.S. military secretly escorted ships carrying more than 100 million barrels of oil out of the Strait of Hormuz, moderating global oil prices.

YEN REMAINS IN FOCUS

Meanwhile a Bank of Japan rate hike at a June 16 policy meeting is now almost fully priced in, meaning it is unlikely on its own to trigger a significant reversal in yen weakness if delivered.

"It's going to take some hawkish commentary from Governor (Kazuo) Ueda that signals the BOJ could bring forward its next hike from December to September - with the possibility of a third hike before year-end," Tony Sycamore, market analyst at IG, said in a note. "Without that or something similar, the Ministry of Finance will likely need to pull out its cheque book again to defend the currency." The Japanese yen was steady against the greenback at 160.475 per dollar, continuing to hover around the 160 level that is widely viewed as a line in the sand for official intervention. A Reuters poll of economists indicated the BOJ will raise its key interest rate this month and again in the fourth quarter, taking borrowing costs to 1.25% by the end of the year, as it grows more wary of inflation risks than downside hazards to the economy.

DOLLAR SOFTNESS The Canadian dollar advanced 0.1% against its U.S. counterpart after the Bank of Canada left its benchmark interest rate unchanged on Wednesday, though Governor Tiff Macklem reiterated that the central bank would not hesitate to raise rates if necessary to keep inflation in check.

Sterling was 0.1% higher against the dollar on Wednesday, as investors closely monitored the latest escalation in tensions between the U.S. and Iran ahead of Friday's UK GDP data.

Leading cryptocurrency bitcoin was about flat on the day at $61,949. (Reporting by Saqib Iqbal Ahmed; Additional reporting by Sophie Kiderlin in London and Satoshi Sugiyama in Tokyo; Editing by Kevin Buckland, Will Dunham and Jan Harvey)