By Swati Pandey and Rebecca Howard
SYDNEY/WELLINGTON, July 22 (Reuters) - The Australian dollar appeared to be heading for its largest weekly fall in 2-1/2 months on Friday as markets wagered coming inflation data would trigger a rate cut at home while upbeat U.S. figures aided the American currency.
The Australian dollar AUD=D4 fell 0.31 percent to $0.7468 on Friday, losing 1.4 percent in the week. This is the currency's biggest loss since May, though it does follow seven straight weekly gains.
Investors have cut long positions in case consumer price data on July 27 proves weak enough to spur the Reserve Bank of Australia (RBA) into easing its policy rate to new lows.
The market is pricing in a 60 percent probability of a 25 basis point rate cut to 1.50 percent at the next policy review on Aug.2.
"Traders are keenly awaiting Q2 CPI data for confirmation of the weak inflation trend that was the major influence on the previous RBA rate," said Stephen Innes, senior currency trader at OANDA Australia and Asia Pacific.
"The Aussie dollar bears will still focus on the U.S. economy, which continues to show flickering signs of life."
The Aussie has also flattened on the yen at 79.10 AUDJPY=R , after being as high as 80.77 earlier in the week.
The yen has been weighed by speculation the Bank of Japan would add to its already massive stimulus program, though some doubt any easing would actually fix the country's deflation troubles.
"We expect no lasting effect on Japan's economy and AUD/JPY from even ambitious policy easing by the BOJ. We project AUD/JPY will end September at 74.88," said Joseph Capurso, a senior currency strategist at Commonwealth Bank.
The New Zealand dollar was on a slippery slope after it fell to six-week low on Thursday when the central bank said further rate cuts were likely. cemented expectations for easing at its Aug. 11 meeting. The kiwi dollar NZD=D4 is down 1.8 percent this week, its second straight weekly loss.
"The central bank now needs to deliver the interest rate cut that is fully priced into the market for August and indicate clearly they don't intend to stop there," said OM Financial Private Client Manager Stuart Ive.
New Zealand government bonds 0#NZTSY= gained, sending yields 2 basis points lower at the short end and 2.5 basis points lower at the long end.
Australian government bond futures also gained, with the three-year bond contract YTTc1 up 2 ticks at 98.60. The 10-year contract YTCc1 rose 4 ticks to 98.10.
The premium offered by Australian 10-year debt AU10YT=RR over U.S. Treasuries US10YT=RR has now shrunk to just 35 basis points, the smallest gap since 2001.