Markets | Mon May 25, 2015 3:41am EDT

LONDON

The dollar was firm near a two-month high against the yen on Monday and held gains against the euro after stronger-than-expected underlying U.S. inflation supported the Federal Reserve's case for an interest rate hike later this year.

Fed Chair Janet Yellen's comments that the central bank was poised to raise rates in 2015 also shored up sentiment towards the dollar, traders said.

With markets closed in many European holidays for a holiday, the dollar index .DXY, which measures the greenback against other major currencies, was up 0.2 percent at 96.266, a one-month high.

Against the yen, it traded near a two-month high of 121.78 JPY=, jumping from a low of 120.64 on Friday, helped by a rise in U.S. Treasury yields US10YT=RR. A move above 122.04 would take it to an eight-year peak against the yen.

"I would expect rate expectations to continue to rise and for the dollar's uptrend to continue as a result," said Marshall Gittler, head of global FX strategy at IronFX Global.

Data on Friday showed core U.S. CPI increased 0.3 percent in April on rising housing and medical care costs. It was the largest rise in the core CPI since January 2013 and followed a 0.2 percent gain in March.

"Whether the dollar can breach the 122.04 yen threshold depends on upcoming U.S. data. While a June rate hike is no longer a likelihood, upbeat indicators that would back up Friday's CPI numbers will fan hopes that the Fed will provide hints at the June meeting on when it might hike rates," said Junichi Ishikawa, analyst at IG Securities in Tokyo.

The euro was down 0.2 percent at $1.0995 EUR=, having touched a one-month low of $1.0964 in the Asian session. Some cited victory by anti-austerity parties in Spain as a factor.

The euro hit a three-month peak of $1.1468 on May 15, but has since fallen back on factors including prospects of aggressive bond purchases by the European Central Bank, persisting Greek debt woes and revived demand for the dollar.

The U.S. economy's recovery has not been as robust as many expected, dashing market expectations earlier in the year for the Fed to raise rates in June and prompting investors to push back their expectations to September or later.

Nevertheless, bits and pieces of upbeat data released this month have shown that the economy still stands above those of other developed economies such as the euro zone and Japan.

"The flow is shifting back in favour of the dollar, hurt recently by spotty economic data and receding likelihood of an early rate hike. Comments by policymakers have also helped," said Koji Fukaya, president of FPG Securities in Tokyo.

"A June hike had gone out the window with sentiment for tightening in September and even later receding at one point, but such pessimism has ebbed," he said.