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FOREX -Dollar index extends gains before Fed meet; Aussie falls

* Moves in dollar seen driven by position adjustment

* Fed expected to maintain stimulus programme

* Aussie hurt as RBA chief talks down the currency

By Anirban Nag

LONDON, Oct 29 (Reuters) - The dollar rose against a basket of currencies on Tuesday as investors, already persuaded the Federal Reserve will keep policy ultra-loose in the near term, trimmed bets against it.

The dollar index gained for a second day, rising 0.3 percent to 79.478, drawing support from a stabilisation in U.S. Treasury yields and prospects of month-end demand. However, it held close to Friday's 78.998, its lowest since Feb. 1.

The index has shed about 1 percent this month, after a 2.3 percent drop in September, as investors pushed back expectations of when the Fed would scale back stimulus.

Traders said the latest moves were driven by position adjustments before the Fed's two-day policy meeting starting on Tuesday. Many have sold the dollar in recent weeks, suggesting that if the Fed stands pat on monetary policy, as widely expected, investors could buy back the greenback.

"Investors are expecting a dovish tone from the Fed and that is more or less priced in. There is a lightening of positions before the Fed, but volumes are low - at least 20-30 percent lower than usual," said Alvin Tan, currency strategist at Societe Generale.

Traders said it was unlikely the dollar would be adversely hit should the Fed choose to wait for more evidence of how badly Washington's budget battle hurt the U.S. economy before deciding on whether to reduce stimulus.

That has left the dollar less vulnerable to bad news. Rather, there was scope for it to rally if U.S data began to beat expectations again, traders added. On Tuesday, the focus will be on September retail sales data, with economists forecasting a modest rise.

One beneficiary of the dollar's recent decline has been the euro, which hit a two-year high of $1.3833 on Friday.

However, it fell 0.2 percent on Tuesday to $1.3760, with investors wary the European Central Bank may express discomfort with the single currency's strength in coming weeks.

"One gets the feeling speaking to clients that moves in the euro and expectations that the Fed will be dovish have gone too far," said Manuel Oliveri, FX strategist at Credit Agricole. "To that extent, we think the dollar's downside is limited."

The Australian dollar retreated after Reserve Bank chief Glenn Stevens tried to talk it down. It fell 0.8 percent to $0.9496. Last Wednesday, it touched $0.9758, a four-month high.