By Tommy Wilkes
LONDON (Reuters) - The dollar retreated from three-week highs on Wednesday as traders took some profits before the Federal Reserve's first expected rate rise of 2018 and focused on whether it will indicate three or four increases are likely this year.
The dollar (DXY) fell 0.2 percent against a basket of currencies, after hitting a nearly three-week high on Tuesday. With the U.S. currency weakening, the euro and yen were able to recover some losses made on Tuesday.
The dollar has been stuck in a trading range as investors wait to see whether the Fed will forecast four rate increases this year, instead of the median three seen in December's quarterly forecast.
Following the Fed's announcement at 1800 GMT, Jerome Powell will hold his first news conference as Fed chief at 1830 GMT.
Many analysts doubt the dollar can rally much, since so many investors remain bearish. The dollar sold off in January and February on bets that trade and budget deficits would pull it down. Comments by the Treasury Secretary that a weaker dollar was good for the United States also weighed on the currency.
The Fed "will have to go some to really move the needle on market thinking or indeed, to take the dollar out of its current range and the FX market out of its mindset," said Kit Juckes, chief FX Strategist at Societe Generale (PA:SOGN).
The two-year U.S. treasury yield (US2YT=RR) jumped to 2.3449 percent on Tuesday.
As the U.S. currency fell, the euro (EUR=) - which has been driven by dollar-related news in recent weeks - gained 0.3 percent to $1.2275, having fallen 0.78 percent on Tuesday and hitting a near three-week low of $1.2240.
Adam Cole, chief currencies strategist at RBC Capital Markets, said a "knee-jerk reaction" to the Fed flagging four hikes this year may see the dollar strengthen against the euro.
Cole said he remained moderately bullish on the dollar, because the Fed's raising rates faster than other central banks supported the currency.
Against the yen, the dollar fell 0.2 percent to 106.345 yen
MEXICAN PESO, CANADIAN DOLLAR RALLY
Elsewhere, the Canadian dollar and Mexican peso gained after reports that the U.S. government administration had dropped a demand related to auto exports, removing a barrier to a deal for a new North American Free Trade Agreement.
The Canadian dollar rose 0.5 percent to C$1.3003 to the U.S. dollar
The Australian dollar fell to a three-month low of $0.7679
Australia, a big producer of basic commodities, is among the most vulnerable economies should U.S. protectionism lead to a tit-for-tat reprisal from China, a key consumer of commodities.
Sterling gained 0.5 percent against the dollar to $1.4065