LONDON (Reuters) - The euro rallied on Tuesday after a Reuters story that European Central Bank policymakers will discuss whether to raise interest rates by 25 or 50 points at their meeting on Thursday to tame record-high inflation.

The gains in the euro, which sent it surging away from the sub-parity levels of last week, come as falling expectations for an aggressive 100 basis point hike from the Federal Reserve later this month knocked the dollar.

The euro rose to as high as $1.0254, up 1.1% on the day and its strongest since July 6 as money markets priced in a 60% chance of a 50 basis point hike on Thursday, up from 25% on Monday.

The dollar index dropped 0.8% to 106.64. That was below Monday's low of 106.88 but also well back from the high of 109.29 last week, a level not seen since September 2002.

Analysts are reluctant to turn bullish on the euro given the region's economic headwinds and ongoing concerns about supplies of natural gas and the hit to its economy.

ING analysts said a "still-challenging environment in the euro zone is keeping any bullish sentiment" capped. "We continue to believe that another drop to parity is possible over the coming days," they wrote.

Traders are also biting their nails ahead of Thursday, when gas is supposed to resume flowing through the Nord Stream pipe from Russia to Germany after a shutdown for scheduled maintenance.

Russia's Gazprom (MCX:GAZP) declared force majeure on gas supplies to Europe to at least one major customer, in a letter dated July 14 and seen by Reuters on Monday.

Elsewhere, the Australian dollar soared 1.2% to $0.6894 after Reserve Bank of Australia policymakers said they saw the need for more policy tightening on top of recent hikes.

"The RBA board has lifted the intensity of its rhetoric," Westpac economist Bill Evans wrote in a research note. "Another 50 basis points in August seems highly likely."

The Japanese yen rose but was not far from a 24-year low ahead of a Bank of Japan policy decision on Thursday, with the central bank committing repeatedly in recent days to continued ultra-easy settings.

Sterling gained 0.6% to $1.2017, near Monday's one-week high of $1.2032. It slumped to $1.1761 on Thursday for the first time since March 2020, with Britain facing an acrimonious and divisive contest to replace ousted prime minister Boris Johnson.