Dollar drops before Fed; Swiss franc sharply lower

U.S. dollar, euro and Swiss franc bank notes are seen in a bank in Budapest August 8, 2011.

NEW YORK (Reuters) - The dollar edged lower on Tuesday on expectations the Federal Reserve would adopt further easing to stimulate a slowing economy but analysts said such a move may not be negative for the U.S. currency.

The Swiss franc weakened sharply after growth and trade data showed a growing impact on the country's economy from a strong currency, fueling speculation the Swiss National Bank may lift the floor for the euro versus the franc.

The Federal Open Market Committee, the Fed's policymaking arm, is expected to end its two-day policy meeting on Wednesday with a decision to stock up on longer-term Treasury debt to push longer-term rates lower in a move dubbed "Operation Twist.

Additional monetary stimulus, especially in the case of quantitative easing, in which the Fed buys government bonds for its balance sheet, is often seen as negative for the currency as it increases dollar liquidity and boosts risk appetite.

But analysts said the impact on the dollar from an "Operation Twist" should be limited given it doesn't expand the Fed's balance sheet. Such a move has also already been priced in, which should minimize market volatility.

"Having expanded this month's meeting from one to two days, the central bank has set the market up for a big announcement," said Kathy Lien, director of currency research at GFT in New York.

"The sheer disappointment of the Federal Reserve coming up short by simply meeting expectations could drive the dollar higher," she added.

The dollar index, which tracks the greenback's value against a basket of other major currencies, was last down 0.2 percent to 76.985.

Worries about Europe's debt crisis and a slowing global economy could continue to spur investors to seek safety in U.S. Treasuries, boosting the dollar, analysts said.

The International Monetary Fund on Tuesday lowered its forecast for world growth and cited significant risks to the economic outlook. It said Europe and the United States could slip back into recession.

SNB SPECULATION

The euro last traded up 0.1 percent at $1.3699, with traders shrugging off a downgrade of Italy's credit rating.

It slightly extended gains after the "troika" of the European Union, European Central Bank and International Monetary Fund said good progress was made during a conference call with Greece on the country's debt crisis.

The euro zone common currency had fallen as low as $1.35930 on trading platform EBS, approaching last week's low around $1.3495 -- its weakest since February. A break below that level could pave the way for a test around $1.3410, the 50-percent retracement of its rise from June 2010 to May 2011.

The euro and dollar both rallied against the safe-haven Swiss franc on market talk that the Swiss National Bank was looking to lift its euro intervention target to 1.25 francs from 1.20.

The euro rose 0.7 percent to 1.2155 francs while the dollar was up 0.6 percent at 0.8874 franc.

Some traders downplayed the SNB talk, saying the euro remains vulnerable as Greece's ability to avoid default was still a wild card.

Alan Ruskin, global head of G10 currency strategy at Deutsche Bank in New York, said: "The smart SNB move is to keep the market guessing by maintaining a credible threat of raising the lower limit on euro/Swiss, preferably without exercising the option to raise this limit any time soon."

The dollar was down 0.3 percent 76.34 yen.

(Additional reporting by Julie Haviv; Editing by Diane Craft)