By Joice Alves
LONDON, Feb 1 (Reuters) - The dollar weakened slightly against the euro ahead of Wednesday's eagerly awaited Federal Reserve policy decision, with investors hoping the U.S. central bank will signal an end to interest rate tightening cycle.
The euro, meanwhile, was barely moved by data showing inflation in the bloc had eased for a third straight month in January.
After a series of jumbo rate increases in 2022 to tame inflation, the market expects the Fed benchmark interest rate to be raised by a quarter of a percentage point to 4.75%. That would be the smallest increase since the central bank began raising rates 10 months ago.
Less clear is whether the central bank will continue to signal further increases as evidence mounts that inflation and the economy are both losing momentum.
The dollar index, which measures the U.S. currency against six major peers, fell 0.2% to 101.91. It also slipped in the previous session, partly because of a report showing U.S. labour costs had increased in the fourth quarter at their slowest pace in a year.
With investors pricing in the Fed reaching the end of its rate-hike cycle, the index is far from the 20-year high of 114.78 it touched on Sept. 28. It has fallen for four straight months.
Fed Chair Jerome Powell's words will be closely watched, investors said.
"While Fed officials have insisted that rates will stay high for some time to come, the markets simply don’t believe them, especially when several key inflation indicators have shown that prices are still coming down on a steady trajectory," said Michael Hewson, chief market analyst at CMC Markets UK.
Carol Kong, currency strategist at Commonwealth Bank of Australia, said: "Recent progress on inflation has encouraged market participants to expect the Fed to quickly pivot from interest rate hikes to interest rate cuts."
EURO ZONE INFLATION
Investors said that euro zone inflation data is unlikely to affect the European Central Bank's (ECB) monetary decision on Thursday.
The ECB and Bank of England are both each expected to raise interest rates by 50 basis points (bps) on Thursday.
"The implication that we have from today’s (inflation) data on the next ECB meeting have been minute,” said Simon Harvey, head of FX analysis at Monex Europe.
“There’s no real sign there that suggests the ECB is going to change course as quickly as markets have expected.”
The euro was up 0.3% at $1.0893 while sterling was flat at $1.2320, with media reports that Britain and the European Union have struck a post-Brexit Northern Ireland customs deal doing little to support appetite for the pound.
A British government source told Reuters that no agreement had yet been reached and discussions were ongoing.
Beyond the main event of the Fed meeting, investors will also focus on ISM manufacturing and job opening data due on Wednesday for further indications on the state of the U.S. economy and labour market.
(Reporting by Joice Alves and Harry Robertson in London Editing by Emelia Sithole-Matarise and David Goodman )