(Reuters) - The Indian rupee strengthened on Friday, posting its biggest weekly gain in two months, as benign U.S. inflation reading reinforced expectations of a smaller rate hike by the Federal Reserve next month.
The rupee finished the session at over a one-month high of 81.3250 per dollar, versus its last close of 81.55.
This was the local currency's best week since the week-ended Nov. 11, gaining about 1.7% after it broke out of a narrow trading range.
Public sector (PSU) banks likely bought dollars around the 81.30 levels on Friday, suggesting 81.20 could remain a resistance level for the rupee in the near term, said a private bank trader.
Dealers also cited current levels being attractive for importers to jump in.
The rupee and other Asian currencies advanced while the dollar index extended losses to 102.00 levels following U.S. inflation data.
U.S. consumer prices on a month-on-month basis declined for the first time in more than 2-1/2 years in December, stoking hopes that the Fed could hike rates by a smaller 25 basis points (bps) next month.
Fed fund futures now show just a near 9% chance of a bigger rate hike.
However, not everyone was convinced the Fed would hike rates in line with market expectations, and that could introduce volatility in the rupee.
"We would not rule out a re-test of the 83-per-dollar level within the first quarter," said Vivek Kumar, economist at QuantEco Research, who predicted a 50 bps hike by the Fed.
India's wide current account deficit would also remain one of the main reasons for the rupee's weakness, Kumar added.
Meanwhile, rupee forward premiums rose, tracking a fall in Treasury yields. The 1-year implied yield climbed to 2.26%, its highest since November 2022, with traders saying PSU banks were on bid.
For the week, the 1-year yield was up around 21 bps.