MUMBAI, May 22 (Reuters) - The Indian rupee will take cues from moves in the dollar index and U.S. yields, while bonds may see some profit booking and traders will assess the impact of higher liquidity after the country's decision to withdraw highest denomination currency note from circulation.

India's central bank said on Friday it will start withdrawing 2,000-rupee notes from circulation, although they will remain legal tender. The move may improve banking system liquidity, analysts and economists said.

The rupee fell 0.6% to 82.66 per dollar last week on back of a rise in the dollar index and Treasury yields.

The dollar index has surged over 2% in the past two weeks, helped by hawkish Fed officials and resilient U.S. economic data. Odds of a Fed rate hike in June have been repriced higher, propping up U.S yields.

The rupee saw a low of near-82.80 last week, a level near which most traders expect the Reserve Bank of India to intervene.

The key this week will be whether the dollar is able to maintain its recent upside trajectory and how RBI responds if that happens, a trader at a private sector bank said.

Jigar Trivedi, senior analyst at Reliance Securities, reckons the 83-level is critical and RBI will intervene at that level.

Adjustments in offshore positions will also affect the rupee. Offshore bets on a rally on the Indian rupee are being stymied by the dollar's broad upward move.

Meanwhile, government bond yields are expected to rise as traders may look to book profits after lower-than-anticipated surplus transfer from the RBI to the government for the last financial year.

The RBI board has approved a surplus transfer of 874.16 billion rupees ($10.69 billion) to the government for the fiscal year ended March 31.

The government had budgeted a dividend of 480 billion rupees for fiscal 2023 from the central bank, state-run banks and other financial institutions, but market participants had factored in a figure of above 1 trillion rupees.

India's benchmark bond yield stayed below the key 7% mark for most of last week, but ended at 7.0106% on Friday. Traders expect the benchmark yield to move in the 6.98% to 7.08% range this week.

Bond market sentiment improved sharply after retail inflation was below the RBI's upper tolerance limit for a second straight month in April, and cemented bets that rate hikes in India are completed.

"Bond yields have fallen largely after inflation eased, and we further expect the reading for May to be below 4.2%," said Yogesh Kalinge, vice president at AK Capital Services. KEY EVENTS: • U.S. May S&P Global Mfg PMI - May 23 (7:15 p.m IST) • U.S. April new home sales - May 23 (7:30 p.m IST)

• U.S. Federal Reserve May meeting minutes (11:30 p.m IST) • U.S. week to May 15 - initial jobless claim - May 25 (6:00 p.m. IST)

• U.S. April - PCE price index and core PCE price index - May 26 (6:00 p.m. IST) ($1 = 81.7800 Indian rupees) (Reporting by Dharamraj Dhutia; Editing by Varun H K)