(Changes byline, updates prices, adds quotes)
By Simon Falush
LONDON, Jan 2 (Reuters) - The dollar fell around a cent versus the euro on the first trading day of the new year with investors inclined to bet that coming U.S. economic news would be soft enough to merit more interest rate cuts.
Although U.S. existing home sales data on Monday was a bit better than expected, it did little to alter the downbeat view on the world's biggest economy cemented by the previous week's soft reports on new home sales and durable goods orders.
On the last trading day of 2007, U.S. short-term rate futures were pricing in as much as 96 percent probability of a Federal Reserve rate cut to 4.00 percent on Jan. 30.
That would bring the U.S. benchmark, currently 4.25 percent, into line with euro zone rates, completely erasing the dollar's yield advantage over the euro.
"We're continuing in the same vein in the new year as we ended the old, with the weak outlook for the U.S. economy and the risk of recession leading to dollar weakness," said Jeremy Stretch, strategist at Rabobank.
Market activity was expected to slowly pick up as investors return from Christmas and new year holidays although Japan and China remain on holiday until Friday.
By 1115 GMT, the euro was up 0.7 percent at $1.4688, after rallying more than 10 percent in 2007 <EUR=>.
Against a basket of major currencies .DXY, the dollar dipped 0.44 percent to 76.300, after posting its worst annual performance in four years in 2007 with losses of 8.4 percent.
The dollar was steady at 111.60 yen <JPY=>, while the euro added 0.6 percent to 163.85 yen <EURJPY=>.
The euro rose above 74 pence for the first time in since its 1999 launch <EURGBP=> as investors continued to expect cuts in UK interest rates.
Apart from worries about the U.S. and UK economies, investors appeared to start 2008 in a relatively positive mood, buying high-yielding currencies like the New Zealand dollar <NZD=> and potentially funding such trades with cheap borrowing in the low-yielding Japanese unit.
U.S. DATA EYED
The U.S. Institute for Supply Management index for December is due at 1500 GMT. Forecasts are for a slight dip to 50.4, from 50.8 in November, but estimates range from 49.0 to 52.0. ECON
A move below the 50 mark would signal contraction in the sector. The index's employment component will also be closely watched for clues on the likely outcome of the non-farm payrolls data on Friday.
"If we see a (sub 50 reading on the employment component) today the market will probably have a bit more confidence in the consensus call for payrolls to rise just 70,000 on Friday after 94,000 in November," said Bear Stearns in a note to clients.
The market will also be interested in the minutes of the Federal Reserve's December policy meeting, when it decided to cut the funds rate by 25 basis points.
Thursday features figures on U.S. auto sales for December, a key barometer of consumer demand.
Traders were also keeping a wary eye on money markets to see if funding pressures had eased now that year-end had passed. Early signs were that interbank rates LIBOR had indeed dipped and risk spreads had narrowed somewhat, but analysts emphasised it was early days.
Both the Fed and the European Central Bank pumped huge amounts of cash into money markets ahead of year-end but much of that will have to be repaid in coming weeks.
(Editing by Ron Askew) (Reporting by Simon Falush)