By Kevin Buckland
TOKYO, Dec 6 (Reuters) - The U.S. dollar held firm against major peers on Tuesday, following its biggest rally in two weeks after strong services data in the United States fuelled bets the Federal Reserve may lift interest rates more than recently projected.
The Australian dollar perked up from near one-week lows after the Reserve Bank of Australia (RBA) raised rates for the eighth time in as many months, with an accompanying statement that was slightly less dovish than market participants had expected.
The U.S. dollar index - which measures the currency against six major peers - changed hands at 105.27 in Asian trading, steady after Monday's 0.7% rally, its biggest since Nov. 21.
It had dipped to 104.1 for the first time since June 28 as traders continued to rein in bets of aggressive Fed tightening.
However, it later reversed course as the Institute for Supply Management's (ISM) non-manufacturing PMI unexpectedly rose, indicating the services sector, which accounts for more than two-thirds of U.S. economic activity, remained resilient.
The Federal Open Market Committee decides policy on Dec. 15. Traders currently expect a half-point hike to a 4.25-4.5% policy band and a terminal rate of just above 5% in May.
"The dollar really kicked butt across the board," said Bart Wakabayashi, branch manager at State Street in Tokyo. "I think there was some positioning short dollars, and all the overnight economic releases from the U.S. were very strong and pointed to a hawkish Fed. They'll raise rates as long as the data shows they need to."
U.S. long-term Treasury yields climbed the most since Oct. 20 overnight, sending the yield-sensitive dollar-yen pair 1.83% to as high as 136.835. The dollar continued to have an edge on Tuesday, with the yen at 136.94.
The euro was also flat after an early light rebound, at $1.0492 following a 0.46% slide overnight. Sterling recovered 0.16% to $1.22035 after Monday's 0.88% retreat.
The Aussie dollar rose 0.6% to $0.6738, clawing back some of a 1.4% overnight tumble after the RBA said it was not on a preset course to tighten policy but that inflation was still high. Investors had been on watch for signs of a pause in tightening after inflation unexpectedly cooled last month.
The RBA lifted its cash rate by 25 basis points to a 10-year peak of 3.1% and does not meet again until February.
"Whilst the RBA have spoken of a pause publicly, we may not be as close to one as I originally thought," said Matt Simpson, a senior analyst at brokerage City Index in Brisbane.
"And with the RBA expecting inflation to continue higher and household spending remaining strong as ever, then the RBA may well hike by another 25 bps in February and March before reassessing."
In recent days though, RBA policy has taken a back seat to optimism about an easing of strangling COVID-19 restrictions in China, a top trading partner.
The Aussie reached a 2-1/2-month peak of $0.6851 on Monday, with sources telling Reuters a policy shift in Beijing around COVID could come as soon as Wednesday.
"The story of the past week - and it's really been a driver of dollar selling - has been the expectation of some sort of relief from China's zero-COVID policy, and that of course has huge implications for global trade and the supply chain issues that have been driving global inflation," said Wakabayashi.
(Reporting by Kevin Buckland; Editing by Sam Holmes)