FOREX-Dollar on the backfoot ahead of Bernanke testimony
* Market awaits clues on more QE from Fed chair
* ZEW investor sentiment index drops for 3rd month
* Spain borrowing costs stay elevated after bond sale
LONDON, July 17 (Reuters) - The dollar slipped against the euro and most other major currencies on Tuesday before testimony from U.S. Federal Reserve Chairman Ben Bernanke, who could hint at more monetary stimulus after recent disappointing U.S. data.
With investors positioning for more quantitative easing by the Fed, analysts saw a risk that the dollar may bounce or assets such as stocks and growth-linked currencies could drop if the Fed chief stops short of signalling more stimulus.
Bernanke will deliver his semi-annual monetary policy report to Congress from 1400 GMT.
The Fed last month expanded efforts to keep long-term interest rates low by announcing it would buy an additional $267 billion in long-term bonds while selling short-term securities.
However, it held off from launching a third round of outright bond purchases that would expand its balance sheet, a form of stimulus known as quantitative easing (QE). Bets on more QE grew after disappointing U.S. retail sales data on Monday.
"The market is positioned aggressively for more QE, but I think Bernanke would want to wait for a bit more data, which leaves it at risk of a disappointment and a dollar bounce," said John Hardy, FX strategist at Saxo Bank.
The dollar index was down for a third straight day, dipping 0.1 percent to 83.03. Earlier the index hit a session low of 82.911, its lowest since July 6, but could find support around 82.60/70, the intra-day highs on June 26 and 27.
The dollar was also stuck near one-month lows against the yen, trading at 79.01 yen. Expectations that the Bank of Japan could intervene and check gains by the yen was keeping investors wary of that pair, traders said.
Japanese Finance Minister Jun Azumi hit out at speculators betting on gains in the yen due to weak U.S. economic data, and hinted the government was prepared to intervene to stem excessive moves.
Strategists at Citi said Bernanke will likely leave the door open to give investors some hope for additional measures without making concrete commitments or being clear on timing.
While this would keep the dollar somewhat weaker against most major currencies except the euro, any bounce in the common currency was likely to prove fleeting, given the problems in the euro zone, they added.
The euro hit a one-week high of $1.23178 shortly after the release of the German ZEW survey, which was not as bad as some had feared. Nonetheless, the index which tracks German analyst and investor sentiment, dropped for a third month in July, providing further evidence that the euro zone crisis was taking a toll on Europe's largest economy.
"It was better than expected but not good enough, showing we've still not found a bottom for the recession in the euro zone," said David Kohl, head of currency research at Julius Baer.
The euro was last at $1.2290, up 0.2 percent on the day but still within reach of a two-year low of $1.2162 hit last week.
Traders said huge bets against the euro raised the chance of a short squeeze, but elevated peripheral euro zone bond yields would keep gains in check.
Spanish 10-year borrowing costs remained above 6.85 percent despite the country selling 3.56 billion euros in short-term debt on Tuesday at markedly lower yields than at last month's auction.
Analysts said that despite Tuesday's nudge higher, the euro has become the funding currency of choice after the European Central Bank cut its deposit rate to zero earlier this month. This meant the 800 billion euros that banks were parking with the ECB would leave the euro zone in search of better yields.
The euro hovered near a record low against the high-yielding Australian dollar, trading as high as A$1.1925. It also neared a 3-1/2 year low against sterling and an 11-1/2 year low against the Swedish crown.
The Aussie dollar was also higher at $1.0284, helped by minutes that showed Australia's central bank saw "no need" to cut interest rates at its July meeting because a material easing had already been delivered and data showed the domestic economy had more momentum than first thought.
The Aussie gained against the yen to 81.25 yen while the euro rose 0.4 percent to 97.16 yen.
The Canadian dollar was also higher, trading at C$1.0150 per U.S. dollar before a Bank of Canada rate decision. Analysts expect the BoC will hold its main policy rate at 1 percent, turning to focus on whether the bank will repeat, dilute or omit the message that it may soon need to raise rates.