LONDON, May 18 (Reuters) - The U.S. dollar edged higher on Wednesday, a day after posting its biggest single-day drop in more than two months after U.S. Federal Reserve chief Jerome Powell struck a more hawkish tone as the central bank battles to rein in surging inflation.
Powell pledged that the U.S. central bank would ratchet up interest rates as high as needed, including taking rates above neutral, to kill a surge in inflation that he said threatened the foundation of the economy.
The neutral rate is the level at which economic activity is neither simulated nor constrained and is widely expected at somewhere in the region of 3.5% by mid 2023.
"It's a strong reminder to the market that the Federal Reserve is going to be hiking interest rates, probably at a very accelerated pace, in order to regain their credibility on the inflation front," said Jane Foley, head of FX at Rabobank.
"The hawkish Fed is the reason why sentiment this morning looks a little bit more fragile than it did yesterday."
At 1055 GMT, the U.S. dollar index was up 0.3% at 103.57, after earlier touching a two-week low following Tuesday's 0.9% drop. It hit a two-decade high above 105 last week.
The euro briefly dropped below $1.0500 , reversing an earlier rise to a one-week high, a day after European Central Bank policymaker Klaas Knot said a 50 basis point rate increase in July was possible if inflation broadens.
Knot is one of the more hawkish ECB members, Commerzbank analysts noted, adding that his view did not necessarily reflect the majority view on the ECB board.
"Nonetheless, by making this comment Knot opens up a new line of attack for the ECB hawks," Commerzbank analyst Ulrich Leuchtmann said in a note.
On Wednesday, more ECB policymakers were banging the drum for interest rate hikes in the coming months. Money markets now expect as much as 108 bps of rate hikes through the rest of the year.
Finnish central bank chief Ollie Rehn said the ECB should move relatively quickly out of negative interest rate territory to avoid unanchored inflation expectations, while Spain's Pablo Hernandez de Cos said rates will likely start to rise early in the third quarter.
The euro was not immediately affected by the comments or by data that showed consumer price inflation reached a record high 7.4% in April, although this was revised down from a preliminary estimate of 7.5%.
The single currency was last 0.3% lower at $1.05175.
Sterling fell as low as $1.23725 as data showing British inflation surged 9% last month to its highest annual rate since 1982 piled pressure on policymakers.
The Australian dollar dropped 0.1% to $0.7025 as Australian wage growth ticked up by only a fraction last quarter, leading investors to scale back bets on larger increases in interest rates.
Cryptocurrency markets were fairly quiet after last week's turmoil. Bitcoin slipped around 2% and was last trading a fraction below $30,000. Ether was holding above $2,000 but was still down just over 2%.
Reporting by Samuel Indyk and Alun John; Editing by Simon Cameron-Moore, David Clarke and David Evans