By Wayne Cole and Charlotte Greenfield
SYDNEY/WELLINGTON, March 6 (Reuters) - The Australian and New Zealand dollars were on the defensive on Monday as the mounting risk of an imminent hike in U.S. interest rates steadily eroded the currencies' yield advantage over the U.S. dollar.
The Aussie AUD=D4 was off 0.25 percent at $0.7575 and uncomfortably close to a recent one-month trough of $0.7543. The currency shed almost 1 percent last week as the U.S. Federal Reserve surprised many by highlighting the chance of a rate hike this month.
In contrast, the Reserve Bank of Australia (RBA) has recently underlined the outlook for no change in its current record-low cash rate of 1.5 percent. The central bank holds its March policy meeting on Tuesday is considered certain to stay on hold. AU/INT
Domestic data out on Monday did nothing to change the equation with retail sales bouncing a modest 0.4 percent in January as expected. a result the premium offered by Australian government two-year debt AU2YT=RR over its U.S. counterpart has dwindled to just 54 basis points, the smallest since early 2006.
"Yield spreads continue to steadily grind in the USD's favour, hitting fresh 10-plus year highs daily amid hawkish Fed March hike signals and a steady run of strong data," said Westpac analyst Richard Franulovich.
"Spreads can fuel yet further USD gains going forward, with market pricing of 63 basis points in Fed hikes in 2017 still shy of the Fed's 75 basis point median."
The New Zealand dollar NZD=D4 fell 0.3 percent to $0.7016, and back toward six-week lows at $0.7003.
"We think there is good support for the Kiwi at the 0.70 level and, to the extent that recent weakness might reflect a positioning shake-out, we wouldn't be surprised to see some sort of recovery in the week ahead," said Jason Wong, currency strategist at BNZ, in a research note.
The main downside risk was a global dairy trade auction due early Wednesday, which futures markets suggested would see prices for the country's largest export earner fall sharply amid increased supply.
New Zealand government bonds 0#NZTSY= eased, sending yields 1 basis point higher at the short end of the curve.
Australian government bond futures were subdued, with the three-year bond contract YTTc1 off 2 ticks at 97.940. The 10-year contract YTCc1 was steady at 97.1650 as the yield curve flattened. (Editing by Simon Cameron-Moore)