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FOREX-Dollar steady as housing data stem U.S. yield drop

(Updates market action, changes byline, dateline, previous LONDON)

* Dollar near Thursday's two-month low vs yen

* Strong housing starts data curb further U.S. yield drop

* Euro on the back foot as euro zone periphery back on the radar

By Richard Leong

NEW YORK, May 16 (Reuters) - The dollar held steady against major currencies on Friday as selling of the currency faded with benchmark U.S. yields stabilizing at their lowest levels in six months, although the greenback faces further weakness if yields resume their decline.

The dollar pared earlier losses against the yen and euro after a stronger-than-expected report on U.S. housing construction but is still on track for its biggest weekly losses since early April.

"Falling yields have been problematic for the dollar," said Richard Franulovich, senior currency strategist at Westpac Banking Corp. in New York.

The drop in the dollar and U.S. Treasuries yields came in the face of encouraging domestic economic data in recent weeks. On Friday, the government said housing starts rose 13.2 percent to 1.07 million annualized units in April, the strongest level since November 2013.

The bond market rally has confounded analysts and traders who reckoned it will eventually peter out and the dollar will rebound from current levels.

Benchmark U.S. 10-year Treasury yields were last at 2.516 percent after hitting a six-month low of 2.473 percent on Thursday. The 10-year yield is set to fall nearly 11 basis points this week.

The dollar traded at 101.55 yen, above a two-month low of 101.31 yen set on Thursday. Chart support for the dollar lies at 101.20 yen, close to some intraday lows touched in March and the dollar's 200-day moving average.

The greenback was little changed against the euro, trading at $1.3715 after falling to $1.3648 on Thursday, its lowest since late February. The euro was down about 0.5 percent for the week against the dollar, putting it on track for its second straight weekly decline.

Against the yen, the euro was flat at 139.17 yen after hitting a three-month low of 138.77 yen earlier.

Disappointing euro zone growth figures on Thursday heightened expectations the European Central Bank will embark on more stimulus at its June policy meeting, and some investors are betting that the euro could grind lower in coming weeks.

Traders also pointed to funds moving to safety after a sell-off in Greek bonds halted a rally in debt of weaker euro zone members. The sell-off in peripheral bonds, if it gathered pace, was likely to hurt the euro, traders said.

The yield on 10-year Greek bonds edged up 2 basis points to 6.851 percent, its highest since late March.

"We have a lot of volatility in Europe especially the last two days. I find it hard for the euro to rally from here," Franulovich said.

The implied one-month euro/dollar volatility, the expected price swings over the coming month, has risen this week from 7-year lows to 5.8 percent on Friday.

(Additional reporting by Anirban Nag in London; Masayuki Kitano in Tokyo; Editing by Chizu Nomiyama)