Dollar weakens as Japan takes back focus from Fed

NEW YORK (Reuters) - The U.S. dollar weakened on Wednesday after the Federal Reserve's statement was seen as increasing the possibility of a September rate hike, but not strongly pointing toward one, and as investors turned attention back to the Japanese central bank meeting on Friday.

Fed policymakers kept interest rates unchanged and said they continued to monitor inflation data and global economic and financial developments, but indicated less worry about possible shocks that could push the U.S. economy off course.

The dollar initially rallied on the more hawkish tone of the statement, before giving back gains as indications of a possible September rate hike were not seen as very strong.

“September is live but they don’t say it as you would have hoped if they were going to signal a hike,” said Richard Franulovich, senior currency strategist at Westpac Banking Corp in New York.

Attention also quickly turned back to whether the BOJ will disappoint investors hoping for a large stimulus announcement when it concludes its meeting on Friday.

The prospect of more stimulus in Japan has overshadowed the Fed meeting this week.

“Yen is probably the only story we’ve had for the past week-and-a-half or so,” said Mark McCormick, North American head of fx strategy at TD Securities in Toronto.

“We have some headlines that the stimulus could be a little bit higher than people had been anticipating, and that’s been dovetailing with what the expectations are around the BOJ,” McCormick said.

The dollar gained to $1.096 against the euro immediately after the Fed statement, before weakening back to $1.1056. Against the yen, the greenback gained to 105.95 yen, before falling back to 105.43 .

The yen weakened earlier on Wednesday after Japan's prime minister unveiled a surprisingly large $265 billion stimulus package to reflate the world's third-largest economy.

The size of the Japanese package, at more than 28 trillion yen ($265.30 billion), exceeded initial estimates of around 20 trillion yen.

It will also add pressure on the BOJ to match the measures with monetary stimulus on Friday.

Japan's Ministry of Finance also denied a report by the Wall Street Journal on Wednesday that it is considering issuing 50-year bonds for the first time to capitalize on ultra-low interest rates.

(Editing by Jonathan Oatis and David Gregorio)