(Reuters) – The U.S. dollar fell on Wednesday after data showed the Chinese economy slipped into deflation last month, which raised the chances of China launching additional stimulus measures and nudged investors into risk assets.

Dollar selling by state-owned Chinese banks helped the yuan rally from a one-month low, dealers said. The Chinese central bank’s stronger-than-expected exchange-rate fixing at 7.1588 per dollar before the open signalled its discomfort with the yuan’s recent declines.

The greenback was last down 0.2% against the yuan at 7.2246.

The dollar index, which measures the performance of the U.S. currency against six others, slid 0.2% to 102.30, reversing Tuesday’s rise.

The euro rose 0.2% to $1.0978, while sterling dipped to $1.2735.

European markets gained after equities tumbled the day before as the Italian government announced a surprise 40% windfall tax on banks.

Italy’s finance ministry subsequently clarified that the one-off measure which targets gains from banks’ higher interest rates, would not amount to more than 0.1% of their total assets. But the initial decision stripped 3.5% off major euro zone lenders’ shares.

In China, the country’s consumer prices fell for the first time in more than two years in July. Rather than lifting safe-haven appetite for the dollar, the figures reinforced the view that the Chinese government might take steps to underpin the economy with monetary stimulus.

“Risk aversion has receded enough to temper safety buying of the dollar. On top of that, the greenback’s bounce this week has left it ripe for profit-taking ahead of tomorrow’s inflation report,” said Joe Manimbo, senior market analyst, at Convera in Washington.

“Hopes that China’s economy is slowing to the point that Beijing will be compelled to step up stimulus and Italy scaling back its windfall tax were better received by markets,” he added.

Investors are now focused on Thursday’s U.S. inflation data, which looms large in a market hungry for clues on the path for Federal Reserve policy.

For now, the data is likely to carry more weight for investors than a retreat in price pressures in China, said Chris Scicluna, head of economic research at Daiwa Capital Markets.

“The central bankers, whether it’s the Fed, or the ECB (European Central Bank) or the Bank of England, are concerned about services prices and also about the overall tightness of the labor markets and that’s not going to change because of what is going on in China,” he noted.

There were also more dovish signals from Fed officials overnight, with Philadelphia Fed President Patrick Harker suggesting interest rates are high enough already, echoing the view of Atlanta Fed President Raphael Bostic.

The message has been far from uniform though, with Fed Governor Michelle Bowman saying on Monday further hikes are likely.

Money markets show most traders expect no change from the Fed at its policy meeting in September. There is just a 13.5% chance of a quarter-point rise, according to the derivatives market.

========================================================

Currency bid prices at 10:06AM (1406 GMT)

Description RIC Last U.S. Close Pct Change YTD Pct High Bid Low Bid

Previous Change

Session

Dollar index 102.3100 102.5200 -0.20% -1.140% +102.5800 +102.2900

Euro/Dollar $1.0993 $1.0956 +0.35% +2.60% +$1.0995 +$1.0955

Dollar/Yen 143.3400 143.3750 -0.01% +9.34% +143.5250 +143.0000

Euro/Yen 157.60 157.07 +0.34% +12.33% +157.6200 +156.9200

Dollar/Swiss 0.8753 0.8758 -0.06% -5.34% +0.8783 +0.8733

Sterling/Dollar $1.2747 $1.2749 +0.00% +5.42% +$1.2782 +$1.2713

Dollar/Canadian 1.3427 1.3416 +0.08% -0.90% +1.3454 +1.3405

Aussie/Dollar $0.6545 $0.6545 +0.06% -3.93% +$0.6571 +$0.6527

Euro/Swiss 0.9621 0.9593 +0.29% -2.77% +0.9632 +0.9586

Euro/Sterling 0.8624 0.8593 +0.36% -2.49% +0.8627 +0.8590

NZ $0.6066 $0.6064 -0.12% -4.61% +$0.6094 +$0.6050

Dollar/Dollar

Dollar/Norway 10.1890 10.2640 -0.71% +3.84% +10.2790 +10.1900

Euro/Norway 11.2053 11.2411 -0.32% +6.78% +11.2690 +11.1850

Dollar/Sweden 10.6647 10.7055 -0.04% +2.47% +10.7441 +10.6430

Euro/Sweden 11.7252 11.7298 -0.04% +5.16% +11.7590 +11.6841