FOREX-Dollar takes breather after rally; euro near 3-month low

Reuters

* Dollar index hovers near previous day's 2-month high

* Euro firmer but still mired near a 3-month trough

* Aussie buoyed by solid outlook for local business investment (Updates prices, adds comments)

By Ian Chua and Masayuki Kitano

SYDNEY/SINGAPORE, May 29 (Reuters) - The dollar hovered near a two-month high against a basket of major currencies on Thursday, taking a pause after rallying due to a shake-out of long positions in sterling and a drop in the euro.

The dollar index eased 0.1 percent to 80.490, staying within sight of Wednesday's high of 80.581, its highest level since early April. A break above 80.599, the April 4 peak, will take the index back to highs not seen since mid-February.

The euro edged up 0.1 percent to $1.3604, holding slightly above a three-month low of $1.3587 set on Wednesday.

Expectations of some policy action from the European Central Bank (ECB) have been mounting, a key reason for the recent underperformance in the euro. A Reuters poll of 48 economists showed a clear majority expect the ECB to cut its deposit rate into negative territory next week.

The euro will probably stay on the defensive going into the ECB meeting on June 5, said Satoshi Okagawa, senior global markets analyst for Sumitomo Mitsui Banking Corporation in Singapore.

Going forward, the recent decline in U.S. bond yields may help limit the scope of the euro's declines against the dollar, he added.

"Given how much U.S. yields have fallen, I doubt that you can chase the dollar higher that aggressively although there may be some short-covering," Okagawa said.

Sterling edged up 0.1 percent to $1.6728, regaining a bit of ground after shedding 0.6 percent on Wednesday in its biggest one-day fall in four months.

Sterling struggled to gain traction even in the wake of hawkish-sounding remarks from Bank of England (BOE) policymaker Martin Weale. He was quoted as saying the BOE should raise interest rates sooner rather than later, but now was not the time to start.

Traders were mostly at a loss to explain the greenback's rise on Wednesday, apart from pointing to month-end dollar demand.

Rather than trying to pin the moves on fundamentals, BNP Paribas analysts said the overnight action could be explained by "a more idiosyncratic exit from extended FX positions."

They said market participants were perhaps wary of a rise in volatility that would undercut carry trades in the lead up to the ECB rate review and that investors were ever-watchful for a reversal in U.S. yields.

The dollar sagged against the yen in the wake of a drop in benchmark Treasury yields to their lowest level in nearly 11 months, a move that usually undermines the greenback's appeal.

The dollar eased 0.1 percent to about 101.73 yen, down from a two-week high near 102.15 yen touched earlier this week.

The U.S. 10-year Treasury yield last stood at 2.438 percent , having fallen to as low as 2.434 percent on Wednesday, its lowest level since early July last year.

The Australian dollar rose 0.4 percent to $0.9272, underpinned by an encouraging outlook for Australian business investments.

Australian business investment fell again in the first quarter but spending plans for 2014/15 were revised higher, a positive for the economic outlook.

(Editing by Eric Meijer)

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