The dollar rose towards this week's two-month high against major currencies yesterday, underpinned by expectations that the threat of rising inflation could prevent the Federal Reserve from cutting interest rates aggressively. Rising food and agricultural prices, as well as high energy costs, come in the face of a slowing US economy hit by the fallout of subprime mortgages and tensions in money markets.

Investors are keen to see Tuesday's US housing data, along with quarterly earning results from a few major US investment banks scheduled this week, including Goldman Sachs due later, to see how the financial sector is coping with the credit squeeze. Interest rate markets price in an around 88 percent chance that the Fed would follow up its interest rate cuts this year with another in January. Such an easing had been fully priced in earlier this month, before last week's strong inflation data.

While prospects of steady US interest rates weigh on stocks and risky assets, the dollar benefits as a rate cut would shave the yield premium over the euro and yen that the currency offers. ?We are in a consolidation phase here with a somewhat strong dollar. (Inflation data) definitely supported it because it will make the situation tricky for the Fed?, said Johan Javeus, currency strategist at SEB in Stockholm.

?We have a tug of war between slowing US growth which is becoming more widespread and inflation expectations which all central banks are concerned about ... (But) as we approach the year end, it's a flow-driven market and people are positioning ahead of it. These flows can affect currencies.?

By 0835 GMT the dollar index, which measures its strength against a basket of six major currencies, was steady on the day at 77.436 .DXY, having hit a two-month high on Monday. The euro was down 0.15 percent at $1.4383 while the dollar was up a quarter percent at 113.13 yen. The euro was up 0.1 percent at 162.73 yen.

The high-yielding Australian dollar gained 0.3 percent to $0.8592. The currency drew support after minutes from the Reserve Bank of Australia's December policy meeting showed it saw strong reasons for raising interest rates, although it held off from doing so because of the global credit squeeze.

Investors are also awaiting the outcome of this week's liquidity injection plans by top central banks. The Bank of Canada and the Bank of England are following central banks in Switzerland, the euro zone and the United States later in auctioning funds.

The results of the liquidity measures are due today. US housing starts data for November is due later, which is expected to show more deterioration in the US housing sector.

?Any way you look at it, the US housing market remains in dire straits ... The tightening in lending conditions in the wake of the subprime crisis has resulted in even more pressure on the housing market?, Calyon said in a note. ?Easier monetary policy from the Fed will help, but the underlying problems of oversupply and falling demand suggest that there are further downside risks to both sales and prices over the coming months.?

<B>Natsuko WAKI</B>