By Ambar Warrick 

-- The dollar hovered around two month lows on Friday after falling sharply on data that showed U.S. inflation eased more than expected, with Treasury yields also down as investors positioned for a smaller interest rate hike by the Federal Reserve in December.

The and were flat on Friday after plummeting 2.2% in the prior session to their lowest point since mid-September. fell below 4% and hit an over one-month low. 

Data on Thursday showed grew 7.7% in October, its slowest pace in nine months. The reading showed that a series of sharp interest rate hikes by the Fed this year were now beginning to have the intended effect of bringing down inflation. It also drove up expectations that the Fed will now slow its pace of rate hikes in the coming months.

Data from exchange operator CME showed that market expectations for a 50 basis point (bps) hike by the Fed in December from the previous day’s reading of 56.8%. Expectations for peak U.S. interest rates also dropped below 5%.

This shift comes amid an increasing number of Fed members expressing support for smaller rate hikes in the coming months to avoid damaging the economy. The central bank had also signaled that it was considering such a move during its meeting earlier this month.

But given that inflation is still well above the Fed’s 2% target, the central bank is unlikely to halt its hiking cycle anytime soon. Fed Chair Jerome Powell has also signaled that interest rates may peak at higher levels than expected, if inflation proves to be stubborn in coming down.  

“The Federal Reserve will keep hiking given inflation remains well above target amid a growing economy with a tight jobs market, but today's outcome is very supportive for it to "step down" to a 50bps hike at the December meeting,” analysts at ING wrote in a note.

Risk-driven markets rallied on the prospect of a smaller hike in December, with Wall Street indexes gaining sharply on Thursday.