Dollar under water, euro up on short-covering spurt

SYDNEY (Reuters) - The U.S. dollar was weak near 2-½ month lows against a basket of currencies on Friday, while a burst of short-covering lifted the euro through key resistance levels in what could be a taste of things to come.

Traders say investors were shifting funds away from the U.S. dollar and toward the euro due to combination of factors like easing concerns about sovereign debt problems in the euro zone, worries about a U.S. recovery and strong U.S. earnings results. Lower U.S. Treasury yields also undermined the greenback. <US/>.

In Asian trade, the dollar index .DXY was down at 82.43, with near term support seen at 82.24, the daily high on April 25. The next support is seen around 81.47, the 50 percent retracement of the index's rise from a low of 74.17 in November 2009 to a high of 88.59 on June 8.

The euro rose to $1.2920, from around $1.2813 late in New York on Thursday when it gained 1.4 percent and marked its best day in two weeks. It also cleared the 100-day moving average at $1.2914 as well as a key retracement barrier at $1.2916.

Traders said efforts to cover bets against the euro that had built up in recent months have accelerated its rise, as did demand for euro call options with strikes at $1.2825, $1.2835 and $1.2855.

"The overall performance gives some confirmation that a descending trendline in the euro since December 2009 has been broken, though the medium-term sustainability of this break remains an open question," David Watt, senior currency strategist at RBC Capital wrote in a morning note.

"At present however, there are more serious concerns about unfolding events in the U.S. economy. Rate spreads are also weighing on dollar, with EU-U.S. two-year swap spread vaulting 50 basis points for the first time since early February, when the euro was at $1.37."

U.S. data this week, including retail sales and producer price numbers have printed on the softer side, raising questions about the sustainability of a U.S. recovery.

Earlier this week, minutes of the Federal Reserve's latest meeting revealed policymakers may need to do more to boost the economy if a sputtering recovery slows further.

That was in sharp contrast to the euro's fortunes. The single currency has risen more than 8 percent after smooth government debt auctions in Greece, Portugal and Spain eased concerns about the euro zone's sovereign debt problems.

The dollar was under pressure against the yen, trading at 87.45 yen, down from 87.53 late in New York on Thursday when it shed more than 1 percent. Near term support is seen at 86.96 yen, the low hit on July 7.

Traders in Tokyo said the dollar/yen pair could see some position adjustment requirements ahead of long weekend in Japan and some buying interest on dips. Japanese markets are shut on Monday for a public holiday.

But overall, the yen is likely to maintain a firm trend with a flat U.S. yield curve likely to encourage Japanese investors to repatriate profits.

Meanwhile, the Australian dollar held ground above 88 U.S. cents, helped mainly by a soft U.S. dollar. But the New Zealand dollar eased after inflation data was weaker than expectations.

The kiwi fell to $0.7230 from about $0.7270 before the data.