FOREX-Dollar slides as U.S. government shutdown takes toll

Reuters

* Dollar index falls to near 8-month low

* Euro hits 8-month high, Italy still seen a major risk

* Aussie soars after RBA holds rates

By Anirban Nag

LONDON, Oct 1 (Reuters) - The dollar fell to a 1-1/2 yearlow against the safe-haven Swiss franc and a near eight-monthlow against a basket of currencies on Tuesday as the first U.S.government shutdown in 17 years spooked markets.

Expectations the shutdown will hurt the economy and promptthe Federal Reserve to postpone withdrawal of monetary stimulusweighed on the U.S. currency.

The selloff gathered pace in European trade with the dollarindex falling to 79.864, its lowest since Feb. 13, anddown 0.4 percent on the day.

The dollar's weakness lifted the euro to aneight-month high of $1.3589. The single currency was also helpedby the prospect of Italian Prime Minister Enrico Letta'scoalition government surviving a confidence vote on Wednesday.

The Swiss franc hit a 1-1/2 year high of 0.89925 francs perdollar on trading platform EBS.

Speculation the U.S. shutdown could prompt an early releaseof the closely watched monthly U.S. jobs report added to marketuncertainty..

Reflecting the nervousness, near-term implied volatilities,a gauge of how choppy a currency is likely to be, rose. Theone-month euro/dollar implied volatility rose to 7.5 percent,from around 6.6 percent on Friday.

"We do not know how long this impasse in the U.S. will last.If it persists, there is a chance it will hurt economic growthand affect chances of Fed tapering - all of which is dollarnegative," said Daragh Maher, strategist, at HSBC.

"In the short term, it's better to avoid the dollar."

A potentially bigger political battle looms over raising theU.S. government's borrowing authority. Failure to do so bymid-October could result in a historic U.S. default.

The dollar also lost 0.3 percent to 97.835 yen,moving back toward a one-month low of 97.50 yen hit on Monday,according to EBS data.

The dollar's weakness offered some reprieve to the yen,which has been under pressure, with the Japanese government ontrack to raise the national sales tax to 8 percent in April from5 percent.

To soften the tax's impact, Prime Minister Shinzo Abe willunveil on Tuesday an economic stimulus package worth 5 trillionyen or more, according to a final draft seen by Reuters.

Some are not convinced the economy can absorb the tax hikeand are expecting more easing from the Bank of Japan.

"There are concerns whether the economy is robust enough tocope and our suspicion is that the decision increases thepressure to ease monetary policy further," Tom Levinson,strategist at ING wrote in a note.

"While this argues for yen losses, more immediately, U.S.debt ceiling concern leaves dollar/yen vulnerable to a retest of97.50."

The Australian dollar soared after the Reserve Bankof Australia kept its cash rate at a record low of 2.5 percent,and offered little guidance on the chance of further cuts.

The Aussie jumped 1 percent to $0.9416.

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