The U.S. dollar rose to the highest level of the year Tuesday, as a slump in both the pound and the euro highlighted the Federal Reserve's increasing isolation on rate hikes among major global central banks as growth outside the United States slows and inflation remains puzzlingly tepid despite rising commodity prices.

The Fed starts its two-day interest rate meeting later today in Washington, and while no change in the central bank's key lending rate is expected when the official decision in published Wednesday, market expectations continue to suggest new chairman Jerome Powell and his Open Markets Committee colleagues remain committed to three more rate hikes between now and the end of the year as domestic inflation accelerations and unemployment declines. 

"Having raised interest rates only last month the Federal Reserve will pause for breath this week; consistent with its policy stance of 'gradual increases'," wrote ING's chief international economist James Knightley. "Nonetheless, the case for tighter monetary policy remains strong with the recent data flow likely to give the Fed the confidence to raise rates another three times this year."

"Interestingly, there has been a growing hawkishness to much of the commentary from Federal Reserve officials, Knightey noted. "As such, the accompanying statement is likely to retain an upbeat bias and we continue to see the balance of risks skewed towards a more aggressive Fed response to combat fears of economic overheating."

The U.S. dollar index, which tracks the greenback against a basket of six global currencies, was marked 0.79% higher on the session at 92.56 in early New York trading hours, the highest since Jan. 9. Benchmark 2-year Treasury note yields, which are more sensitive to changes in interest rate perceptions, rose to 2.508% and 10-year note yields, which are more likely to move on growth projections, rose to 2.975%.

U.S. consumer prices, according to the the personal consumption expenditures (PCE) index, jumped to an annual rate of 2% last month, the Commerce Department said Monday, the biggest gain in more than a year and bang-in-line with the Fed's 2% inflation target. The so-called core PCE index, which strips out volatile food and energy costs, accelerated to 1.9% from 1.6% in the previous month.

The dollar was also notably stronger against the euro, which drifted 0.74% lower at 1.1985 after data from Germany on Monday showed that inflation in Europe's largest economy slowed to 1.4% in April, down from 1.5% in March and well below the European Central Bank's 'just below 2%' consumer price target.

The greenback also gained 1.03% against the pound, which traded at an early January low of 1.3620 after private sector manufacturing data published earlier Tuesday hinted at the slowest rate of growth in 17 months. That grim assessment followed a much softer-than-expected reading of first quarter GDP, which slowed to 0.1% from 0.3% in the first quarter, that has clipped expectations for a near-term interest rate hike from the Bank of England.

Curiously, both the Bank of England and the European Central Bank have either walked back, or had market expectations do it for them, from previous signals that suggested both wish to either raise rates (as was the case for the BoE) or pull back on bond purchases (as was the case for the ECB).

HSBC yesterday changed it view on BoE rates, suggesting no further moves from the central bank this year and downward revisions to UK GDP in the months ahead. 

ECB President Mario Draghi told markets last week that, while underlying inflation is "expected to rise gradually over the medium term, supported by our monetary policy measures, the continuing economic expansion, the corresponding absorption of economic slack and rising wage growth", he also cautioned that they remain "subdued and have yet to show convincing signs of a sustained upward trend."