FOREX-Dollar falls as economy hopes cool risk aversion

* Dollar falls vs euro as risk aversion cools * Euro edges up, shaking off weak French output data

* UK industrial output rise lifts sterling GBP=

(updates throughout)

By Harpreet Bhal

LONDON, June 10 (Reuters) - The dollar declined across the board on Wednesday led by a retreat in risk aversion as stock prices in Europe and Asia were lifted by investor optimism about an improvement in the global economy.

The greenback's decline snapped gains made early in the week on anticipation that positive data from the United States may prompt the Federal Reserve to raise interest rates by year-end, a view which was now being reassessed by the market.

Advancing stocks reflected renewed interest in riskier assets, supporting higher yielding currencies including the Australian and New Zealand currencies at the expense of the dollar.

"Risk appetite seems to be taking over now and with equities moving higher and volatility coming down, all these issues are working against the dollar," said Ian Stannard, senior FX Strategist at BNP Paribas.

The FTSEurofirst 300 .FTEU3 was up 1.7 percent by 0934 GMT. In Asia, sentiment was buoyed by reports of stronger-than-expected industrial output in China, which helped to push Japan's Nikkei stocks average .N225 to an eight-month closing high.

Stannard said the dollar was also partly dragged down by the view that central banks may diversify away from dollar reserves after China said last week it would buy as much as $50 billion in bonds issued by the International Monetary Fund (IMF).

"This is quite a clear signal that reserve managers are looking at various alternatives to more traditional dollar products so diversification is a theme which will continue to haunt the dollar," Stannard said.

China's Vice Foreign Minister He Yafei said on Tuesday that the largest holder of official currency reserves had no intention of abandoning U.S. dollar assets, saying no one was taking about "dumping the dollar" [ID:nBJC000331].

MIXED OUTPUT DATA

The euro EUR= edged up 0.2 percent against the dollar to $1.4097, unfazed by a greater-than-expected fall in French industrial output in April, which contracted 1.4 percent against a fall of 0.2 percent predicted by economists [ID:nL9732978].

Despite the big fall, some analysts said that a further weakness in French production would be less pronounced.

"Manufacturing production will continue to fall in the second quarter but the rate of decline in industrial production should be less marked, as the latest business survey in industry shows a slight stabilisation in confidence in April-May," Calyon said in a note to clients.

Other production figures were more optimistic, with data showing Italian industrial output rose 1.1 percent in April on a seasonally adjusted basis, marking the first increase after nearly a year of monthly declines [nLA1008551].

Meanwhile the pound climbed 0.3 percent GBP= to $1.6371 after data showed UK industrial output rose unexpectedly by 0.3 percent in April for the first time since February 2008, a sign that Britain's economy may be emerging from a recession.

Rising risk demand helped to push the Australian and New Zealand dollars each up roughly 1 percent against the dollar.

Against a basket of currencies, the dollar fell 0.15 percent to 79.727 .DXY, off the high of 81.466 hit on Monday after positive jobs data from the U.S. heightened expectation that the Fed would move to raise interest rates earlier than anticipated.

U.S rate futures trimmed such expectations and short-dated Treasuries rallied on Tuesday, pulling yields down from recent seven-month highs, after a solid auction of three-year notes.

But longer-dated issues struggled as the market awaited its big test in the form of $19 billion in 10-year notes for sale on Wednesday and $11 billion in 30-year bonds on Thursday.

Market participants awaited a two-day meeting of finance ministers from the Group of Eight nations in Italy beginning on Friday, although few in the market expected that foreign exchange would take the spotlight at the gathering.

A French Finance Ministry source told Reuters the participants would not discuss currency issues due to the absence of central bankers at the meeting. [ID:nPAB007678] (Additional reporting by Tamawa Desai; Editing by Toby Chopra)