Dollar hits lows, tankan gives yen brief support

By Satomi Noguchi

TOKYO (Reuters) - The dollar hit record lows against the euro and a basket of currencies on Monday, after tame U.S. inflation data bolstered the case for more Federal Reserve interest rate cuts.

Investors are now awaiting the Institute for Supply Management's manufacturing index due later in the session for further clues on the health of the U.S. economy.

Some analysts said the dollar was likely to remain weak regardless of economic data due this week until Friday's U.S. jobs report, which will have a major impact on near-term Fed monetary policy.

The headline figure in the Bank of Japan's September tankan survey came in slightly above the market forecast, keeping alive expectations for a BOJ rate rise in coming months, but the data gave the yen only a brief boost.

"The dollar is likely to stay broadly weak ahead of Friday's U.S. jobs report because the market will not be sure of buying the dollar back until the actual result of the jobs data comes," said Etsuko Yamashita, chief economist at Sumitomo Mitsui Bank.

The euro was slightly lower on the day at $1.4263 having pulled back from record highs above $1.4280 hit on electronic trading platform EBS earlier on Monday.

The dollar index, a gauge of the greenback's value against a basket of six major currencies, rose slightly to 77.760, having trimmed some losses after hitting a record low of 77.657 earlier in the morning.

The dollar extended its losses after falling late last week as the Federal Reserve's favoured inflation gauge showed a muted rise in core consumer prices.

The 1.8 percent year-over-year increase in the core PCE price index brought the reading within the Fed's presumed comfort zone of 1 to 2 percent.

The data supported market expectations for the U.S. Federal Reserve to cut interest rates further on top of its hefty 50-basis-point cut to 4.75 percent in September.

Economists expect the ISM manufacturing index for September, due at 1400 GMT, to show a median reading of 52.6, slightly below 52.9 in August.

Traders said there was some wariness over the euro's heady rise since mid-August, with technical indicators such as the relative strength index suggesting the single currency has been overbought.

"No one wants to buy at these levels," said a senior trader for a North American bank, referring to the euro.

But there was no clear-cut reason to turn bearish against the euro at this point, he said.

"It just won't stop. There isn't much reason to sell and it seems like the trend will continue," the trader said, adding that a rally to around $1.46 by year-end was not out of the question.

Yamashita at Sumitomo Mitsui bank said a hawkish policy stance by the European Central Bank after its rate-setting meeting this week could support the euro, though the central bank is seen holding its interest rate steady this time.

Underscoring the dollar's broad weakness, the Australian dollar climbed to an 18-year high at $0.8928

YEN STAYS WEAK

The yen gained briefly after the BOJ tankan but faltered as investors returned to carry trades in which the low-yielding currency is used to fund investments in higher-yielding currency and assets.

While the BOJ tankan headline showed diffusion index (DI) for big manufacturers' sentiment was unchanged from the previous survey at plus 23, it was above the market's median forecast of plus 22.

"Since the DI for big manufacturers did not decline and the capex numbers were strong, it seems to have triggered some yen buying initially," said Masafumi Yamamoto, currency strategist for Nikko Citigroup.

The dollar, which had stood near 114.90 yen just before the tankan, slipped to below 114.80 yen on the data.

But the dollar later recouped its losses to stand at 114.95 yen, up 0.1 percent from late U.S. trading on Friday.

Yamamoto said the tankan probably won't alter the outlook for the Bank of Japan's monetary policy in any drastic way, but added that it may prompt some investors to think that a BOJ rate rise to 0.75 percent by year-end cannot be ruled out.

The tankan showed big firms expect their capital spending to rise by 8.7 percent in the year ending March 31, compared with the market's median forecast for a 7.5 percent rise.

But analysts said the tankan was mixed overall. The DI for big non-manufacturers came in slightly below expectations, as did the DIs for both small manufacturers and non-manufacturers.