Dollar softens as investors weigh Middle East jitters against inflation data

BENGALURU/HONG KONG, July 21 (Reuters) - The U.S. dollar held steady on Tuesday as markets balanced signs of escalating tensions in the Middle East against lingering optimism from softer inflation data last week.

The U.S. dollar index, which measures the currency against a basket of six peers, was largely unchanged at 100.97 after hitting its highest since July 15 in the previous session, while the euro was marginally higher at $1.1421.

Lack of clarity on where the U.S.-Iran conflict is headed has left the dollar in limbo as markets lack conviction to place significant bets.

The U.S. military has struck Iran for ten straight nights, reigniting tensions and prompting investors to dial back hopes that the conflict would end soon.

Iran also targeted U.S. sites in Bahrain, Kuwait and Jordan. That kind of escalation typically drives flows into safe-havens such as the dollar.

At the same time, efforts to find a diplomatic solution remain active. A senior Iranian official told Reuters on Monday that Tehran had received a proposal from mediators for a 10-day ceasefire.

A murky inflation outlook has added uncertainty to the markets. Benign U.S. inflation data released last week has already taken some wind out of the dollar by curbing bets on further interest-rate hikes.

"A sustained depreciation of the U.S. dollar looks more like a 2027 story. We expect the dollar to remain firm over the next few months until the inflation picture becomes clearer," said Jimmy Jean, chief economist and strategist at Desjardins.

Traders are pricing in a 63.1% chance of a rate hike at the Federal Reserve's September meeting, compared with 90% from before the latest inflation print was released, according to data compiled by LSEG.

However, questions over where prices go from here persist, as the outlook for global inflation hinges on how soon shipping through the Strait of Hormuz returns to normal and oil markets stabilize.

Brent crude futures rose 1.4% on Tuesday and have surged nearly 24% this month.

The Canadian dollar steadied after dropping to a one-month low, after the U.S. imposed a new tariff of 50% on a wide range of Canadian products in response to Ottawa's "discriminatory treatment" of American-made cars, alcohol and dairy goods.

The British pound erased early gains and was last down 0.15% against the dollar to $1.3411, as investors monitored the developing political landscape.

Andy Burnham became Britain's seventh prime minister in a decade on Monday, and reiterated his commitment to stick to the previous government's fiscal rules. John Healey, the former defence secretary, was appointed the new finance minister.

Burnham has yet to set out details on how he intends to meet his objectives while sticking to election pledges of not raising taxes on working people.

"The greatest near-term risk lies with the UK's fiscal outlook and Burnham's plans around the prior government's self-imposed fiscal rules," Scotiabank's chief FX strategist Shaun Osborne wrote.

Markets are now focused on a European Central Bank meeting due later this week. Economists polled by Reuters expect the central bank to hold interest rates steady this time, but still hike at least once more later this year.