FOREX-Dollar slips vs euro after rally; outlook still upbeat


* Dollar index down from two-month peak

* Solid U.S. jobs data keeps December tapering view alivefor now

* Diverging Fed/ECB policy path expected to mute euro

By Gertrude Chavez-Dreyfuss

NEW YORK, Nov 11 (Reuters) - The dollar fell on Monday aftera two-day climb against the euro after investors locked ingains, but its prospects remained upbeat as expectations grewthat the Federal Reserve might scale back stimulus sooner thanexpected after strong U.S. jobs data.

A U.S. government holiday on Monday kept many investors onthe sidelines and volumes low. While the euro managed to retracesome of its recent losses, analysts cautioned against readingtoo much into Monday's trading.

The overall expectation is for the dollar to performfavorably versus the euro, following a shock interest-rate cutfrom the European Central Bank and a blockbuster U.S. jobsnumber last week. That robust employment figure has everybodytalking about a December reduction in the Fed's bond buying,which should be positive for the greenback because it means thatthere would be less dollars in the financial system.

"Actual or expected tapering will be positive for thedollar. Further delays of tapering will alter the path but notthe ultimate level of the dollar: higher than here," saidStephen Jen, co-founder of London-based investment firm SLJMacro Partners.

The euro climbed to $1.3412 on lower-than-usualvolumes, but gains were capped as investors began to sell itfrom around $1.3400 through to $1.3410. The euro hit a two-monthlow of $1.3295 last Thursday after ECB cut its main interestrate to a record low 0.25 percent.

The euro-zone currency was last trading up 0.3 percent at$1.3407.

David Song, currency analyst at Daily FX in New York, saidthis was more of a relief bounce in the euro. "I think the eurocould be in line for another move lower from here," he said.

Against the Japanese yen, the dollar gained 0.1percent to 99.19 yen.

The dollar index slipped 0.3 percent to 81.093, aftersetting a two-month high at 81.482 following Friday's reportshowing U.S. employers added 204,000 jobs in October - wellabove the forecast for an increase of 125,000 jobs.

The data was even more surprising as it came in a month whena budget standoff in Washington forced a 16-day governmentshutdown, suggesting that the U.S. economic recovery was on afirmer footing than previously thought.

As a result, U.S. Treasury yields rose, with the gap betweentwo-year U.S. Treasuries and their Germancounterparts at its widest since mid-July. U.S. bondmarkets were shut on Monday and with yields rising quickly inthe past week, some expect Treasuries to consolidate.

The benchmark 10-year U.S. Treasury note's yield was also near a two-month high as some investors brought forwardto December their expectations of when the Fed will start towithdraw its stimulus.

That underpinned the dollar as rising yields make a currencymore attractive to hold. After the government shutdown, most hadpushed back the Fed's "tapering" expectations to March 2014.


Speculators have cut long euro positions, and this trendcould gather momentum with the euro zone facing a prolongedperiod of slowing inflation. That could see the ECB deployingmore aggressive monetary easing instruments.

"We think investors are caught long near $1.3450, witheuro/dollar primed for a move toward $1.32 - a level euro-zoneand U.S. two-year yield differentials would point toward," saidChris Turner, chief currency strategist at ING in London.

Just $2.89 billion in euros traded on Monday, according toReuters Dealing data , making it the lowest-volume dayfor the euro since Oct. 21.

Although the ECB's rate-setting committee was split aboutThursday's decision to cut rates, Executive Board member BenoitCoeure said on Saturday that the bank could trim interest ratesfurther and provide more liquidity.


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