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By Toni Vorobyova
LONDON, Dec 11 (Reuters) - The dollar hit a one-month high versus the yen and firmed against other currencies in choppy trading on Tuesday ahead of a widely anticipated rate cut from the Federal Reserve later. The U.S. central bank is expected to lower rates by at least a quarter point from the current 4.50 percent as the economy wrestles with a housing market downturn.
Investors are pricing in a one-in-four chance of a more aggressive 50 bps cut in benchmark rates, along with expectations for an up to 75 bps cut in the discount rate -- at which banks borrow from the Fed -- to help financial institutions shore up their balance sheets before the year-end.
A lower cost of borrowing is a double-edged sword for the dollar as it supports growth but at the same time reduces the yield premium dollar-denominated assets offer.
Recently markets have put more weight on the growth-boosting properties of U.S. rate cuts, buying dollars on expectations that loser monetary policy may help the world's biggest economy avoid a recession.
With some investors squaring their books for the end of the year and others reluctant to put on new positions ahead of the Fed decision, traders said that thin volumes were exacerbating flows- and technical-related market moves.
"The dollar has held up well. We are suffering from a relative lack of liquidity... and I think ahead of the Federal Reserve announcement you will probably continue to get these sudden moves," said Simon Derrick, head of currency research at Bank of New York Mellon.
By 1122 GMT, the euro was down 0.3 percent at $1.4666, sliding off a session high of $1.4750 <EUR=> hit earlier.
The dollar was up 0.3 percent at 111.95 yen <JPY=>, having hit a one-month high of 112.13 yen <JPY=>.
The yen has fared badly in recent sessions, due to a pick up in risk appetite. UBS said its FX risk index, at 0.88, indicated that risk appetite was at its highest in over six weeks.
The Fed last narrowed the differential between benchmark and discount rates in August.
"Credit markets remain dysfunctional with interbank lending at only the shortest of terms. The problem remains that market participants want greater clarity on the soundness of their counterparties," Calyon said in a note to clients.
"This will take time but the Fed will continue to encourage institutions to use the discount window's primary lending facility to help with liquidity issues. We believe that there is a better than 50/50 chance that the Fed will cut the discount rate to 4.50 percent reducing the penalty to only 25 bps over the Fed funds target."
Dollar money markets have stabilised in recent sessions more than euro or sterling ones as investors hoped for Fed measures to ensure year-end liquidity.
Standard Chartered said the Fed could extend the period of funding from the discount window to 90 days from the current 30.
ABN Amro said other options could be to widen the range of collateral accepted for discount window borrowing, or simply to inject more money into the market with repo auctions. (Editing by Ron Askew)