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Thursday July 31, 2008 - 11:47:42 GMT
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FOREX NEWS-Dollar falls as economy fears linger, US GDP eyed

Thu Jul 31, 2008 7:44am EDT

(Refiles to remove extraneous material)

* Dollar index falls 0.1 percent to 73.231 .DXY

* Surging euro zone inflation keeps ECB rate cuts off agenda

* U.S. GDP, payrolls data awaited for clues on economy

(Changes byline, adds quotes, updates prices)

By Simon Falush

LONDON, July 31 (Reuters) - The dollar retreated from recent one-month highs against the euro on Thursday, as lingering doubts over the health of the U.S. economy capped upside progress for the currency.

The euro also found support as July inflation in the euro zone rose to a record 4.1 percent -- more than twice the European Central Bank's 2 percent ceiling -- reinforcing a view that interest rates are set to stay at 4.25 percent for the rest of the year.

Market reaction was muted however as the figures were in line with economists expectations.

"The inflation numbers are...more biased to rate increases, although there is negative sentiment on the growth dynamic," said Phyllis Papadavid, currency strategist at Societe Generale.

Even though data has recently pointed to a sharply slowing euro zone economy, ECB members Nout Wellink and Guy Quaden both stressed the need to manage inflation expectations.

(For details of ECB comments please double click on [nL0137666])

Threats to U.S. growth are still worrying investors despite data showing a 9,000 gain in ADP private sector jobs in July [ID:nN30438138], with analysts warning against euphoria before key U.S. non-farm payrolls on Friday.

"We don't think the recent strength in the dollar will be sustained into a long-term turnaround as the macro underpinning is not there," SocGen's Papadavid said, adding that she expects the euro to retest its high above $1.60 against the dollar in the autumn.

"There has been a close correlation between risk aversion dollar and we expect the dollar to suffer more when further bad news emerges," she said.

By 1113 GMT, the euro was up 0.2 percent at $1.5612, having hit a one-month low of $1.5518 the previous day. The dollar fell 0.15 percent against a basket of six major currencies to 73.204 .DXY.

The dollar gained 0.1 percent to 108.18 yen <JPY=>, not far off a one-month peak of 108.33 yen struck the previous day.


The dollar's fortunes started to turn up earlier in the month as the euro zone, Japan, Australia and many other economies show signs of losing steam nearly a year after the credit crunch erupted.

The U.S. currency rose sharply on Wednesday, after the unexpected rise in ADP private sector employment raised hopes that the pace of slowing in the U.S. economy was starting to ease.

However, the International Monetary Fund said on Wednesday the U.S. dollar's decline has moved the currency closer to medium-term equilibrium, but staff estimated that its value is still somewhat on the strong side. [nN30372623]

Investors will look to second quarter U.S. GDP growth data released at 1230 GMT for more clues on prospects for the economy.

"The U.S. calendar today may put an end to recession talk as U.S. 2Q GDP is expected to show growth of 2.0 percent after consecutive quarters of 1.0 percent and lower," said Forex Capital Markets in a note to clients.

"Although the majority of the gain will come as a result of the fiscal stimulus plan, any improvement above the 1 percent infusion by the government will be seen as a dollar positive."

A Reuters consensus forecast sees second quarter GDP growing at 2 percent.

Friday's payrolls report is viewed as key because Fed officials have indicated their discomfort with a pick-up in inflation pressures, but persistent job losses make it difficult for the Fed to consider lifting rates from 2.0 percent.

The expansion of emergency lending facilities by the Fed, ECB and Swiss National Bank had briefly helped the dollar, showing that top central banks were seeking to keep money flowing through strained money markets and prevent a renewed downturn. (Reporting by Simon Falush) (Editing by Victoria Main)

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