(Recasts, updates prices, adds quote)
By Steven C. Johnson
NEW YORK, Dec 17 (Reuters) - The dollar rose against the euro on Monday, boosted by year-end transactions as well as speculation that U.S. inflation may cause the Federal Reserve to be less aggressive in cutting interest rates next year.
But tight credit conditions and fear of slower U.S. growth weakened the greenback elsewhere, with the yen and Swiss franc rising as investors unwound carry trades that involve borrowing these currencies to fund purchases of higher-yielding assets.
U.S. equities also fell as investors worried that rising inflation and signs of weak holiday retail sales would further darken the economic outlook for the world's largest economy.
"Risk reduction is leading to some strength for the yen and Swiss franc, though there's latent dollar strength, too, as people have been short dollars for some time and may be taking year-end profits," said John McCarthy, director of trading at ING Capital Markets in New York.
He said the market mood remains mildly favorable for the dollar heading into year-end, partly on the view that rising U.S. inflation may keep the Fed from cutting benchmark short-term rates at its next policy meeting on Jan. 30.
"I think they want to see solid evidence that there is pervasive economic weakness before they cut again, because I do think inflation is still a very real concern," he said.
In mid-afternoon New York trade, the euro traded down 0.2 percent at $1.4393 <EUR=>, after earlier dipping to a 1-1/2-month low of $1.4332 in overseas trade.
But the dollar fell 0.4 percent to 112.94 yen <JPY=> and 0.3 percent to 1.1490 Swiss francs <CHF=>. The euro also fell 0.6 percent to 162.54 yen <EURJPY=>. Sterling gained 0.2 percent to 2.0204 <GBP=>.
The Fed is still expected to lower rates in 2008 to shield the economy from a slumping housing market, but analysts think lurking price pressures could force officials to adopt a slower pace of monetary easing.
This would not significantly erode the dollar's yield advantage, since global growth worries are likely to prompt other major central banks to cut rates or hold them steady.
Recent data showed U.S. consumer prices in November posted their biggest gain in more than two years. Even the report's nonfood, non-energy "core" component beat forecasts.
Interest rate futures are reflecting about a 90 percent implied chance of a quarter-percentage-point interest rate cut in January, down from around 100 percent last week. Earlier on Monday, they fell to around 70 percent.
The Fed was also due to offer the first $20 billion of 28-day funds through its Term Auction Facility on Monday, with the European Central Bank and the Swiss National Bank also offering cash.
While it's still early days, some in financial markets have started worrying about stagflation -- a period of rising prices and slower growth. Such a scenario would complicate the Fed's job and bode ill for the dollar.
Earlier on Monday, an economist with the San Francisco Fed said the credit crisis, falling home prices and high energy costs have increased U.S. vulnerability to a recession. For more, please see [ID:nN17414596].
"With oil prices rising sharply, I think it's one of the things we have to be concerned about," said Michael Woolfolk, senior currency strategist at The Bank of New York Mellon.
An unexpected surge to $114 billion in U.S. long-term capital inflows in October, well above September's $15.4 billion inflow, lent some dollar support, though analysts were sceptical about the data's relevance.
"The dollar was weaker when all of these flows were occurring," said Alan Ruskin, chief market strategist at RBS Greenwich Capital in Connecticut.
"The data will still leave the debate wide open as to whether the dollar's most recent recovery is predicated on higher dollar yields/rate spreads, or represents an early start to better dollar seasonals in January," he said in a note. (Additional reporting by Lucia Mutikani; Editing by James Dalgleish)