FOREX-Dollar dips in thin trade, but brightening economic outlook cap losses

Reuters

* Major currencies in holding pattern

* Christmas holiday keeps markets subdued

* U.S. consumer spending posts largest increase in five months

* International Monetary Fund will raise U.S. growth forecast

By Gertrude Chavez-Dreyfuss and Julie Haviv

NEW YORK, Dec 23 (Reuters) - The dollar drifted lower against the euro on Monday in thin trading, but optimism about the U.S. economy as the Federal Reserve started to withdraw some of its stimulus capped the currency's losses.

Major currencies were in a holding pattern due to a holiday in Japan, while most of Europe began winding down on the last full trading session before the Christmas break. That left many investors and speculators to square positions and trim long dollar positions before year-end.

U.S. consumer spending posted its largest increase in five months in November, the latest reading of sustained strength in the economy as the year winds down.

The report fit the Fed's upbeat view on the economy, which prompted the U.S. central bank to announce last week that it would start reducing its monthly bond purchases from January.

Yields on U.S. ten-year notes edged higher, while U.S. stocks surged to record highs, pushing the dollar lower. But year-end moves are temporary -- the trend for the dollar is still higher going into 2014.

"As the Federal Reserve reduces its bond purchases, interest rates in the U.S. will rise, attracting foreign investment out of Asian economies that are vulnerable to weaker Chinese growth," said Kathy Lien, managing director at BK Asset Management in New York. "More foreign investment will be positive for the dollar."

In late trade, the euro traded 0.2 percent higher against the dollar at $1.3696, above a two-week trough of $1.3623 on Friday. Against the yen, the common currency was 0.2 percent higher as well at 142.54, not far from a five-year high of 142.89 reached last week.

The dollar was flat versus the yen at 104.08 yen, not far from a five-year peak of 104.63 yen touched on Friday.

Sentiment globally was underpinned by Friday's upbeat U.S. GDP data and the Fed's decision last week to start scaling back its bond-buying stimulus.

International Monetary Fund Managing Director Christine Lagarde said on Sunday the international lender would raise its U.S. growth forecast for the world's largest economy next year. Part of the reason why the dollar remains sought-after is that short-dated Treasury yields are still moving higher, driven by expectations the Federal Reserve will continue to trim its bond-buying program in coming months.

The 10-year Treasury yield rose and forthcoming activity out of the United States continues to outperform.

Rate differentials will likely continue to favour the dollar.

"The Fed is likely to continue to wind down asset purchases, and this should provide underlying support for the dollar," wrote BNP Paribas in a research note.

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