Australia, NZ dollars grapple with risk aversion before inflation test

SYDNEY, Jan 24 (Reuters) - The Australian and New Zealand dollars were at the mercy of global risk aversion on Monday as most equity markets extended their decline, while investors awaited a key reading of domestic inflation, which could impact on interest rates.

The Aussie was flat at $0.7180 and well short of last week's peak of $0.7275. Support lies at $0.7170 while resistance comes in at $0.7277 and $0.7314.

The kiwi dollar lagged badly at $0.6707, just a whisker from its December trough of $0.6702. A break would take it to territory not visited since late 2020 and risk a further decline to at least $0.6590.

Markets were tense ahead of a Federal Reserve policy meeting at which it is expected to open the door to a U.S. rate rise as soon as March and to winding back its vast balance sheet, which could drag on risk assets.

Domestically consumer price figures on Tuesday could set the stage for the Reserve Bank of Australia (RBA) to end its bond buying in February and reinforce market wagers for a hike as soon as May or June.

Median forecasts are for the CPI to rise 3.2% on the year in the December quarter, while core inflation is seen picking up to its fastest since 2014 at 2.4%.

Both National Australia Bank and Commonwealth Bank of Australia predict trimmed mean inflation will hit 2.5%, putting it back in the middle of the RBA's 2%-3% target band two years earlier than predicted by policy makers.

"This would mean the RBA would need to revise up their CPI forecasts and we think the Bank will be able to forecast core inflation being at the mid-point of the 2-3% band across their entire forecast horizon," said Taylor Nugent, an economist at NAB.

"Come the RBA's February meeting, QE is clearly gone, while for the rates view much depends on its willingness to tolerate inflation at or above target as it waits until wages growth is closer to 3% plus."

The bond market has already priced in a lot of tightening risk with three-year yields up at 1.14% and near levels last visited in mid-2019.

The Reserve Bank of New Zealand (RBNZ) is well ahead of the game having already hiked twice and fully expected to move again at its meeting on Feb. 23.

However, higher rates have done the kiwi no favours, with the currency two cents lower than when the RBNZ first pulled the trigger in October. (Editing by Sam Holmes)