FOREX-Dollar slides on U.S. growth worries, euro squeeze

* Dollar hits 2-month low vs currency basket, euro

* Fed comments, weak data increase U.S. growth worries

* Short-covering lifts euro 10 cents vs dollar since June (Adds comments, details; changes byline)

By Steven C. Johnson and Vivianne Rodrigues

NEW YORK, July 15 (Reuters) - The U.S. dollar fell broadly on Thursday, and the euro soared to a two-month high above $1.29 as soft inflation and manufacturing data added to concerns about the strength of the U.S. economy.

U.S. producer prices declined for a third straight month, the Labor Department reported. The data came just a day after minutes of the Federal Reserve's latest meeting revealed that policy makers think they may need to do more to boost the economy if a sputtering recovery slows any further.

The news helped push the euro to its highest against the dollar since May. The single currency, which slid below $1.19 in June on euro-zone debt trouble, has since risen by more than 8 percent after smooth government debt auctions in Greece, Portugal and Spain eased concerns.

Weak reports on New York and mid-Atlantic factory activity also hurt the dollar, as did Wednesday's data showing retail sales fell for a second straight month. For details, see [ID:nN15208925].

The data "is going to give traders further reason to dump the dollar as the risk shifts from Europe to the United States," said Kathy Lien, director of FX research at GFT Forex in New York. "Overall, U.S. fundamentals are making the U.S. less attractive to investors."

The euro rose 1.3 percent to $1.2901 EUR=, marking its best day in two weeks. Traders said efforts to cover bets against the euro that had built up in recent months have accelerated its rise, as did demand for overnight euro call options with strikes at $1.2825, $1.2835 and $1.2855.

Positioning and technical considerations suggest "a move toward $1.30 is realistic," said Derek Halpenny, head of Europe currency research at BTM/UFJ.

The dollar also fell against other currencies, declining 1 percent to 87.53 yen JPY= and hitting a 5-1/2-month low against the Swiss franc at 1.0401 francs CHF=. Sterling rose 0.7 percent to $1.5374 GBP=D4, just off a 10-week high.

TREND SHIFT?

The dollar index .DXY, which measures the greenback against six major currencies, hit a two-month low and has now given back more than a third of its rally since last November.

It was last down 1 percent at 82.585.

Citing the weaker U.S. growth outlook, Goldman Sachs now forecasts the euro to trade at $1.22 in three months' time rather than $1.15, as it predicted in June. Its six- and 12-month forecasts are $1.35 and $1.38, respectively, compared with $1.15 and $1.25 a month ago.

But BNP Paribas strategist Sebastien Galy chalked the move up to frenzied short-covering on the euro and said a flat U.S. yield curve was encouraging Japanese investors to repatriate profits, thus boosting the yen.

"On the yen, we may have a new trend developing with the market heading toward the dollar at 85," he said.

He expects the euro's gains to be capped, however, as the threat of debt trouble in Europe and the fiscal austerity budgets being adopted across the bloc will ensure sluggish euro-zone growth.

"Sure, the euro could go to $1.31 in the short term because speculators are aggressively short and any move up makes them jumpy," Galy said. "That's an appealing short-term trade and it makes no sense to fight it. But when markets look again at European fundamentals, we'll see a lower euro/dollar."