By Jemima Kelly and Fanny Potkin

By Jemima Kelly and Fanny Potkin


LONDON (Reuters) - The dollar pulled away from seven-week highs on Wednesday, amid speculation that U.S. President Donald Trump's choice for the next head of the Federal Reserve could be a less hawkish candidate than had previously been expected.


The greenback had reached its highest since mid-August against a basket of major currencies <.DXY> on Tuesday, driven by stronger economic data, as well as expectations for another Fed rate hike by the end of the year and a revival of the so-called "Trumpflation trade".


But it fell on Wednesday, after a Politico report that Fed Governor Jerome Powell is favoured over former governor Kevin Warsh by U.S. Treasury Secretary Steven Mnuchin. Both Warsh and Powell were interviewed at the White House last week.


While both are seen as serious candidates to replace current Chair Janet Yellen when her term expires in February, Powell is seen as more dovish than Warsh, who has criticised the Fed's bond-buying programme in the past.

"Only a couple of days ago everyone was going for Warsh as successor, who the market saw as standing for a much tighter U.S. policy," said Commerzbank's head of currency research in Frankfurt, Ulrich Leuchtmann.

"Now everyone is thinking that Powell is the more likely choice and thinking of Powell as someone who will do very very gradual policy incrementations. Warsh is seen as sort of positive, Powell as a negative basically - that's the most important factor at the moment."

A more hawkish Fed candidate would likely prompt investors to bet on more aggressive normalization of the current loose monetary policy, to the dollar's benefit.

The dollar index slipped 0.2 percent to 93.437 <.DXY>, off a seven-week high of 93.92 touched on Tuesday following strong U.S. manufacturing figures.

"The dollar has gained recently on expectations of a Fed rate hike in December and hopes of tax cuts, but the markets have finished pricing in all the positive news," said Shinichiro Kadota, senior rates and FX strategist at Barclays.

"A December rate hike is already factored in while we have to see whether any tax deal will come through," he added.

Dollar money market futures were pricing in about a 70 percent chance of a rate hike by December.

The euro <EUR=> traded at $1.1762, up 0.2 percent on the day and off Tuesday's 1-1/2-month low of $1.16955.

It has been dogged this week by worries over Catalonia, after a violence-marred independence referendum. But the common currency appeared largely unruffled by Catalonia's leader, Carles Puigdemont, saying on Tuesday that the region would declare independence in a matter of days.

The dollar dipped 0.3 percent to 112.55 yen <JPY=>.

Uncertainties ahead of Japan's general election on Oct. 22, where Prime Minister Shinzo Abe faces a challenge from a new party formed by a popular Tokyo Governor Yuriko Koike, clouded the outlook for the currency pair.

(Reporting by Jemima Kelly and Fanny Potkin; Additional reporting by Hideyuki Sano in Tokyo; Editing by Keith Weir)