Gold heads for biggest weekly drop in eight on Fed rate outlook

By Koustav Samanta

BENGALURU (Reuters) - Gold steadied after two days of losses on Friday, but was set for its biggest weekly slide in eight weeks on the back of a firmer dollar and indications from the U.S. Federal Reserve that it could raise interest raise rates sooner than expected.

New York Fed President William Dudley said on Thursday there was a strong sense among the central bank officials that markets were underestimating the probability of policy tightening and that the Fed was on track for a rate hike in June or July.

The comments came a day after the minutes of the Fed's April meeting revealed that most policymakers felt a rate increase might be appropriate as early as next month.

Spot gold was little changed at $1,254.46 per ounce at 0348 GMT, near a three-week low of $1,244 reached in the previous session. The metal is down 1.5 percent for the week, its biggest drop since the week ended March 25.

"The gold environment is now substantially different from what was apparent several weeks ago when a weaker dollar and a benign rate environment were providing an element of support," INTL FCStone analyst Edward Meir said in a note.

"This is no longer the case, as both these variables are no longer as constructive."

The dollar held at its highest in nearly two months against a basket of major currencies early on Friday, on track for a third week of gains as investors positioned themselves for an early rate hike. [USD/]

Gold is highly sensitive to rising interest rates, which increase the opportunity cost of holding it. The metal has rallied 18 percent this year as investors bet the Fed had slowed the pace of rate hikes.

Upbeat U.S. economic data on Thursday further supported views of a rate hike next month.

"I don't think there will be a interest rate hike in June. Maybe a quarter or two is required to push rates higher and the most reasonable time will be Q4, but if they wish to push the hike earlier, it should be in Q3," said Mark To, head of research at Hong Kong's Wing Fung Financial Group.

Holding in SPDR Gold Trust, the world's largest gold-backed exchange-traded fund, rose 0.5 percent to 860.34 tonnes on Thursday, the highest since November 2013. [GOL/ETF]

Among other precious metals, spot silver was likely to post is biggest weekly drop since March with a 3.5-percent decline, while spot platinum and spot palladium were on track for their biggest weekly declines in over four months.

(Additional reporting by Vijaykumar Vedala in Bengaluru; Editing by Joseph Radford)