Dollar rises to 2-week high, Middle East conflict and rate paths in focus

Sept 2 (Reuters) - The dollar hit a two-week high on Wednesday as investors turned to the U.S. currency amid growing concerns about the economic impact of the energy shock and weighed diverging monetary policy paths across major economies.

Iran ‌and its Arab neighbours were plunged back into war on Wednesday by the biggest exchange of fire between Tehran and Washington ‌since July.

The greenback tends to benefit from higher oil prices because the U.S. economy is less exposed to energy shocks than many other major economies, attracting demand at the expense ​of currencies such as the euro and yen.

While most economists expect the European Central Bank to be near the end of its tightening cycle after next week's widely anticipated rate hike, the Federal Reserve is confronting a growing risk of having to tighten policy in 2027.

"We expect the ECB to finish its hiking cycle by the end of the year, while the Federal Reserve will likely be just beginning to raise rates," George Brown, senior economist ‌at Schroders, said.

"That should widen rate differentials in ⁠favour of the dollar and lead to a weaker euro," he added, flagging that Schroders is positioned for a softer euro and expects the single currency to fall to $1.10 against the dollar by year-end.

However, a selloff in ⁠U.S. Treasuries driven by concerns about inflation and the country's fiscal trajectory can weigh on the dollar, as rising debt levels and persistent price pressures raise doubts about the long-term appeal of U.S. assets.

The dollar index, which measures the greenback against a basket of currencies including the yen and the euro, rose 0.20% ​to ​99.865, its highest point since August 17. The euro was down 0.16% at $1.1575, ​after hitting $1.1566, its lowest since August 20.

The yield on the ‌benchmark U.S. 10-year note rose to as high as 4.8182%, its firmest since November 2023. [US/] Japan's benchmark 10-year yield extended its rally to 3.01% on Wednesday after reaching a three-decade milestone of 3% on Tuesday.

Markets are now pricing in a 68% chance of a September Fed hike, up from around 40% a week earlier, according to CME Group's FedWatch tool.

The Japanese yen rose 0.25% against the greenback to 159.89 per dollar, right above the psychologically important 160-per-dollar threshold, as markets weigh the Bank of Japan's rate path.

BOJ Governor Kazuo Ueda said consecutive rate ‌hikes could be a possibility.

Kit Juckes, strategist at Societe Generale, mentioned hawkish comments from ​BoJ board member Hajime Takata.