By Saqib Iqbal Ahmed

NEW YORK (Reuters) – The dollar edged lower against a basket of currencies on Wednesday but remained near the two-decade high touched in the previous session as traders awaited an interest rate decision from the U.S. Federal Reserve later in the session.

An ad-hoc European Central Bank policy meeting helped lift the euro modestly, keeping the pressure on the U.S. currency.

A hotter-than-expected U.S. inflation report on Friday has boosted expectations that the Fed will raise interest rates by more than previously forecast, helping knock investors’ appetite for riskier assets, thereby lifting the haven dollar.

There is a nearly 90% expectation for a 75-basis-point increase at the conclusion of a two-day meeting of the U.S. central bank’s Federal Open Market Committee (FOMC) on Wednesday, according to Refinitiv’s Fedwatch Tool.

But with such a large interest-rate increase already expected, the dollar may struggle to gain further after the Fed’s decision, some analysts said.

“The mild retracement in the broad dollar this morning aligns with the view that market expectations have overextended for the Federal Reserve and that the likeliest outcome for US rates markets is disappointment,” said Simon Harvey, head of FX analysis at Monex Europe.

Against a basket of currencies, the dollar was 0.06% lower at 105.23, but close to the 2-decade high of 105.65 touched on Tuesday.

The dollar found little support from data that showed U.S. retail sales unexpectedly fell in May as motor vehicle purchases declined amid rampant shortages, and record high gasoline prices pulled spending away from other goods.

The euro rose against the greenback earlier in the session on news of a surprise meeting by the ECB, which some traders hoped would address fragmentation risk in the region, but gave up most of those gains in short order.

The so-called fragmentation risk refers to the worry that the ECB’s monetary policy actions may affect the 19 nations that make up the euro zone in differing ways, with some countries logging a significant increase in bond yields disconnected from economic fundamentals.

The European Central Bank will skew reinvestment of maturing debt to help more indebted members and will devise a new instrument to stop fragmentation, it said on Wednesday.

“The ECB meeting provided very little additional information relative to last week’s policy statement,” said Monex Europe’s Harvey.

“Markets now know the central bank is going to look into the anti-fragmentation tool in a more expedited way, but beyond that today’s announcement really fell short of something tangible to excite the euro bulls,” he said.

The euro was up 0.08% to $1.0422, after rising as high as 1.0507 earlier in the session.

Higher U.S. rates versus rock bottom Japanese yields have been weighing on the yen, which hit a new 24-year low of 135.60 per dollar early in the session before erasing losses to trade up about 0.8% against the greenback.

Sterling recovered from its lowest level against the dollar since March 2020 on Wednesday, rising 0.77% to $1.2089 but the reprieve could prove temporary with slowing UK economic growth and a potential trade conflict with the European Union weighing on the currency.

In cryptocurrencies, bitcoin slipped to a new 18-month low of $20,076.05, before paring losses to trade down 3.62% at $21,288.46, dragging smaller tokens down with it and deepening a market meltdown sparked by crypto lender Celsius this week freezing customer withdrawals.

(Reporting by Saqib Iqbal Ahmed; Editing by Nick Zieminski)