The US dollar held broadly steady on Friday but remained on course for a weekly decline after softer US inflation data prompted traders to scale back expectations of an imminent interest rate hike by the Federal Reserve.

Escalating tensions in the Middle East, however, limited pressure on the US currency by strengthening safe-haven demand.

The confrontation between Iran and the United States intensified throughout the week, undermining the ceasefire reached last month and driving investors toward the dollar as oil prices climbed close to their highest levels in a month.

Euro and sterling head for weekly gains

The euro was little changed at $1.145 and was on track to post a weekly gain of around 0.3%.

Sterling edged lower to $1.346 but remained set for a weekly increase of 0.5%, marking a third consecutive week of gains as concerns over Britain's fiscal position eased.

The Japanese yen strengthened slightly to 162.26 per dollar but remained close to the 40-year low of 162.84 reached earlier this month.

Traders remained alert to the possibility of intervention in the foreign exchange market after Japanese Finance Minister Satsuki Katayama reiterated that the government was prepared to take decisive action if necessary.

The dollar index, which measures the US currency against a basket of six major currencies, was unchanged at 100.69 but was heading for a weekly decline of around 0.3%.

The index had fallen to a one-month low earlier in the week as expectations of a near-term interest rate hike faded, although safe-haven inflows helped support the dollar.

"There has been no easing in the pace of escalation in the Middle East, and that continues to limit investors' willingness to sell the dollar," said Derek Halpenny, Head of Research for Global Markets EMEA at MUFG.

"US economic data released yesterday also helped curb selling pressure on the US currency," he added.

July rate hike expectations decline

Data released on Thursday showed that US retail sales rose only slightly in June, as lower fuel prices reduced receipts at gasoline stations while online spending recorded a sharp increase.

The figures prompted economists to raise their estimates for US economic growth in the second quarter.

Separate data also indicated that the labor market remained stable, reinforcing expectations that the Federal Reserve would keep interest rates unchanged at its meeting later this month after June consumer inflation showed signs of slowing.

Policymakers, however, remain cautious about relying on a single month of improved inflation data following several months in which price pressures moved in the opposite direction.

According to the CME FedWatch Tool, the probability of an interest rate hike at the July meeting fell to 11%, from 25% a week earlier, while markets priced in a cumulative 26 basis points of rate increases by December.

"I don't think a rate hike will be under consideration at the July meeting," said Tani Fukui, Senior Director of Global Economic and Market Strategy at MetLife Investment Management.

"We expect no interest rate increases or cuts during 2026," he added.

Among other currencies, the Australian dollar remained on track for a third consecutive weekly gain despite falling 0.24% on Friday to $0.6981 as risk appetite weakened and global equities declined.

The Chinese yuan, meanwhile, pulled back from a one-month high against the dollar but remained on course for a third consecutive weekly gain.