* Dollar down 0.1 pct versus currency basket
* Cautious return of risk appetite after U.S. CPI
* German media report on Greek bailout supports euro
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By Neal Armstrong
LONDON, Feb 22 (Reuters) - The dollar weakened on Monday as investors reassessed the chances of an earlier-than-expected interest rate hike by the U.S. Federal Reserve, prompting a degree of recovery in risk appetite.
Currency markets took the Fed's discount rate decision last week as a signal the U.S. central bank was coming closer to tightening its benchmark rate, despite assurances from Fed policymakers to the contrary.
But a benign U.S. inflation reading on Friday, with consumer prices rising less than forecast in January [ID:nN19117929], caused markets to pull back those rate expectations, in turn provoking a cautious return to risk appetite.
"There is some recovery in risk appetite, with markets believing the CPI data will help to anchor the U.S. rate curve, even though the Fed hiked the discount rate last week," said Ray Farris, chief currency strategist at Credit Suisse.
At 1049 GMT, the dollar was trading down 0.1 percent against a basket of currencies <.DXY>, with the index at 80.553 after hitting an eight-month high on Friday of 81.342 in the wake of the Fed discount rate hike, which surprised some in the market.
The greenback was flat versus the euro <EUR=>, which traded at $1.3605 and gained support from reports that Germany had prepared plans under which countries using the single currency would provide aid worth between 20 billion and 25 billion euros for debt-laden Greece. [ID:nLDE61J05O] [ID:nLDE61L0PR]
Sentiment towards Greece has been weighed down by persistent concerns about its ability to service a spiralling budget deficit, in turn forcing the euro down more than 10 percent from its December 2009 highs.
The single European currency hit a nine-month low of $1.3443 on Friday before bouncing back after the U.S. CPI data. Traders reported sovereign supply capping rallies in euro/dollar in quiet trade on Monday.
Currency speculators raised net euro short positions to a record high in the week ended Feb. 16, and analysts say any bounce in the single currency is merely a positioning adjustment.
"This is just a pause in the overall euro downtrend, the moves we have seen are flow-driven and I would expect more dollar strength to come," said Westpac currency analyst Lauren Rosborough.
For a graphic on euro positioning, click
WAITING FOR BERNANKE
This week, all eyes will be on Fed chief Ben Bernanke's testimony in Congress on Wednesday and Thursday. Investors will be looking for clues on rates after the discount rate rise.
"The increase in the discount rate last week means that Fed Chairman Bernanke's semi-annual testimony will be even more closely watched for any clues as to the pace of U.S. monetary policy tightening." said Barclays analysts in a note.
The U.S. data calendar is light Monday, with the Chicago Fed national activity index for January due at 1330 GMT. Investors will then be watching for a speech from Federal Reserve of San Francisco President Janet Yellen, due at 1600 GMT.
The dollar gave up slight gains versus the yen <JPY=> to trade down 0.1 percent at 91.45 yen. It hit a one-month high of 92.14 on Friday as the greenback made broad-based gains.
The yen trimmed earlier losses against the euro after the slight return to risk appetite had allowed for some buoyancy in carry trades. It traded down 0.2 percent at 124.45 yen after moving back above 125.00 in Asia as equity markets gained.
(Editing by Nigel Stephenson)