Dollar regains ground after hit from disappointing inflation data

NEW YORK (Reuters) - The dollar was little changed against a basket of currencies on Friday, shaking off early weakness, after data showed U.S. consumer prices rose less than expected in September, pointing to muted inflation that could worry Federal Reserve officials.

The Labor Department said on Friday its Consumer Price Index jumped 0.5 percent last month after advancing 0.4 percent in August. Economists polled by Reuters had forecast a 0.6 percent increase.

September's increase was the biggest in eight months, but it stemmed mostly from soaring gasoline prices after hurricane-related production disruptions at Gulf Coast area oil refineries. Underlying inflation remained muted.

The dollar index <.dxy>, which tracks the greenback against six major currencies, was up 0.02 percent at 93.072 after falling to a more than two-week low of 92.749. The index was down about 0.75 percent for the week, its worst weekly performance in five.

"We did see a knee-jerk reaction that was perhaps overdone. On more sober reflection, traders are coming to bid up the dollar," said Karl Schamotta, director of global product and market strategy at Cambridge Global Payments in Toronto.

The Fed has raised its benchmark rate twice this year and signalled a third hike later this year.

Financial markets are pricing a roughly 83 percent probability of a rate increase in December, according to CME Group’s FedWatch tool.

The dollar edged higher after U.S. President Donald Trump struck a blow against the 2015 Iran nuclear agreement, choosing not to certify that Tehran is complying with the deal and warning he might ultimately terminate it.

"Trump's unwillingness to sign the nuclear deal is increasing global risk aversion, making markets more hesitant on the geopolitical outlook," said Schamotta.

The dollar slipped 0.37 percent against the Japanese yen.

Japan is the world’s largest creditor nation and traders tend to assume Japanese investors would repatriate funds at times of crisis, thus pushing up the yen.

The euro was down 0.07 to $1.1821 after European Central Bank President Mario Draghi said the euro zone continues to need substantial monetary stimulus as the ECB has not yet managed to increase inflation sufficiently.

"Draghi did definitely pour some cold water on expectations around ECB's Oct. 26 meeting," said Schamotta.

Britain's pound hit an 11-day high in a volatile day of trading and was heading for its best week in four, benefiting from signs that Britain is to be offered a two-year Brexit transition deal.

(Reporting by Saqib Iqbal Ahmed; Editing by Lisa Von Ahn and Lisa Shumaker)