FOREX-Dollar on defensive, hits fresh 2-year low vs euro


* Euro hits fresh 2-year high

* Dollar index sets fresh 8-1/2-month low

By Lisa Twaronite and Masayuki Kitano

TOKYO/SINGAPORE, Oct 25 (Reuters) - The dollar set a freshtwo-year low versus the euro on Friday, pressured bystrengthened expectations the U.S. Federal Reserve will maintainits asset purchases through early next year.

The dollar also set a fresh 8-1/2-month low versus a basketof currencies and slipped to a two-week low against the yen.

The euro edged up 0.2 percent to $1.3825 and rose toas high as $1.3833, its highest level since November 2011.

The single currency shrugged off data the previous dayshowing the pace of growth in euro zone business unexpectedlyeased this month as global data suggested the recovery remainsfragile elsewhere as well, with U.S. manufacturing outputdropping for the first time in four years.

While there is some caution about the euro's outlook in thewake of its recent gains, the single currency will probably stayfirm over the next few months, said Teppei Ino, an analyst forthe Bank of Tokyo-Mitsubishi UFJ in Singapore.

"I think everybody is wondering whether it is really headingtoward $1.40," Ino said.

Still, the euro seems likely to be supported over the nextfew months, given the backdrop of dollar weakness, he said.

"If the time frame that you're looking at is the rest ofthis year, it's hard to say that the euro will be weak," Inosaid.

In the near term, the euro could take its cues from the German Ifo survey due on Friday.

The dollar index, which measures the greenback's valueagainst a basket of currencies, touched an 8-1/2-month low of78.998.

The dollar index is down about 0.8 percent for the week,having come under pressure after a disappointing U.S. jobsreport vanquished any hope that the Fed would taper its stimulusthis year.

Against the yen, the dollar set a two-week low of 96.94 yen and last stood at 97.00 yen, down 0.3 percent on the day.

Although the expectations for the Fed to keep its massivebond-buying stimulus for longer tend to boost risk appetite andhurt the safe haven yen, the dollar has struggled versus the yenthis week as U.S. bond yields have fallen, eroding thegreenback's yield attraction.

But with the 10-year Japanese government bond yield wallowing at even lower levels and having slippedbelow 0.60 percent on Thursday for the first time since May 9, afocus is whether Japanese investors will step up their overseasinvestments.

"As the JPY weakening trend strengthened over the past year,the main JPY sellers have been foreign investors, especiallyhedge funds," said Citi forex strategists in a research note.

These early bets that Japanese investors would increaseoverseas investments failed to materialise, as Japanese yields did not fall enough to raise the appeal of overseas investments,and institutions instead repatriated funds.

"Now that JGB yields are passing the 'yield threshold' weare seeing an increasing likelihood that Japanese investors willfinally invest more overseas," the Citi strategists said.

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