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Tuesday December 16, 2008 - 12:02:13 GMT
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FOREX NEWS-Euro dips vs dlr but limited before Fed

Tue Dec 16, 2008 6:55am EST

* Euro slips but losses limited before Fed rate decision

* Fed seen cutting rates near zero, focus on more steps

* Euro dn 0.4 pct vs dlr after 2-mth high of $1.3739 <EUR=>

* Euro zone PMIs fall to new records; UK CPI slows less

By Tamawa Desai

(Recasts, adds quotes, updates prices)

LONDON, Dec 16 (Reuters) - The euro eased from a two-month high against the dollar on Tuesday but losses were limited on expectations the U.S. Federal Reserve will cut interest rates to near zero and take more steps to battle recession.

The euro extended losses after purchasing managers' surveys released on Tuesday showed a bleak outlook for the region's economy.

The single European currency had surged against the dollar since Monday as repatriation flows into the dollar ebbed and as market players covered positions ahead of the year end.

"The data reminded markets a bit that the euro zone economy is not in great shape," said Daragh Maher, strategist at Calyon in London.

He added, however, "the euro's losses are relatively modest in the context of its recent sharp gains against the dollar."

At 1122 GMT, the euro was down 0.4 percent on the day against the dollar <EUR=> at $1.3653 after hitting a two-month high of $1.3739 in Asian trade earlier.

A failure to break above a previous high near $1.3780 prompted players to take profits, dealers added.

Data on Tuesday showed euro zone manufacturing and services activity sank to new lows in December, although less than forecast.

The flash estimate of the Markit Purchasing Managers Index for manufacturing fell to 34.5 compared to 35.6 in November. That was slightly above a forecast of 34.3 but left the index way below the 50 level which separates expansion from contraction [nLG637396].

The euro also dropped 1.2 percent to 122.81 yen <EURJPY=>.


But traders were wary of taking on big positions until they see the outcome of the Fed's two-day policy-setting meeting later in the day.

The U.S. central bank is widely expected to cut its key federal funds rate target by at least a half percentage point to an unprecedented 0.50 percent, but futures markets are pricing in a 62 percent probability of a bigger 75 basis point easing FEDWATCH.

Moreover, investors will focus on an accompanying statement for clues on whether the Fed will clearly state it will deploy so-called quantitative easing to restore growth [nLG548641].

Any acknowledgment that the Fed is moving towards a quantitative easing approach by buying up government debt "could sour dollar sentiment in the near term," BTM-UFJ currency economist Lee Hardman said.

Fed Chairman Ben Bernanke said earlier this month that the central bank could purchase long-term securities issued by the Treasury or government-sponsored agencies to cut yields and stimulate demand.

Against a basket of currencies, the dollar .DXY rose 0.1 percent to 82.209 as it edged off a two-month low of 81.875. The U.S. unit fell 0.8 percent against the yen <JPY=> to 89.98 yen.

Traders are also keeping an eye on U.S. consumer price and housing sector data before the Fed's decision.

U.S. consumer prices overall are expected to have fallen 1.2 percent in November after a 1.0 percent decline in the previous month. Excluding volatile food and energy prices, consumer prices likely rose 0.1 percent.

Separately, data showed British inflation slowed less than expected in November but is still forecast to fall sharply soon because of a cut in sales tax and tumbling fuel prices.

The Office for National Statistics said consumer prices fell 0.1 percent last month to bring the annual rate down to 4.1 percent from 4.5 percent in October. That was the lowest rate since June but still well above the government's two percent target. [nLG690878]

In a letter to the government explaining why prices were rising by more than double the official target, Bank of England Governor Mervyn King said on Tuesday that UK inflation could fall below one percent next year.

King also said a fall in sterling and market interest rates should support the outlook for activity and inflation [nBOE001667]. Sterling was down 0.4 percent at $1.5250 <GBP=>. (Additional reporting by Jessica Mortimer; Editing by Victoria Main)

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