FOREX-Euro rally pauses, but gains may resume on ECB optimism

* Prospect of ECB action to help Spain, Italy limits falls
* Euro falls vs sterling after BoE inflation report

By Gertrude Chavez-Dreyfuss
NEW YORK, Aug 8 (Reuters) - The euro slid against the dollar
on Wednesday, weighed down by soft German economic data and
profit-taking after three days of gains, but optimism that the
European Central Bank will act to lower Spanish and Italian
borrowing costs could limit losses.
The euro also sold off against sterling after the Bank of
England gave no indication it would provide further stimulus,
putting more pressure on the euro zone's common currency.
Wednesday's economic numbers took the steam out of the
euro's recent rally. Industrial output in Germany, the euro
zone's biggest economy, fell slightly more than expected in
June. Germany also reported that imports fell in June for the
second time in three months, and exports also dropped.

"The reports reminded investors that regardless of what the
ECB does to bring down government borrowing costs, the real
economies of Europe, even Germany's, continue to decline," said
Omer Esiner, chief market analyst at Commonwealth Foreign
Exchange in Washington.
"Still, the euro's downside should be limited by hopes that
a major move by the ECB is imminent," he added.
Investors are expecting the ECB to step in and buy Spanish
and Italian bonds and rein in their soaring yields.
In midday New York trading, the euro was down 0.3
percent at $1.2367, after hitting a one-month high of $1.2443 on
Monday. It dropped past reported stop-loss orders at $1.2350,
before recovering slightly.
In general, the euro's outlook remained positive on the
daily charts for as long as $1.2132 minor support holds, which
is this month's low, analysts said. The rebound from the $1.2040
trough, a more than two-year low hit on July 24, is expected to
continue.
Some analysts cautioned, however, that any euro rebound will
be susceptible to profit-taking as the euro zone has yet to turn
the corner.
Italy on Tuesday reported that its economy shrank further
into recession in the second quarter, while Germany reported a
fall in industry orders in June that was worse than forecast.

"With the market looking to short euros across a range of
investor types, the ECB's comments last week may well see
euro/dollar squeeze higher through August," wrote Paul Robson,
currency strategist at RBS Securities in London. "However, this
looks set to generate better levels to establish short euro
exposures."
Sterling rose against the euro after BoE
Governor Mervyn King appeared cautious about future interest
rate cuts, surprising investors. The euro last traded down 0.5
percent versus the pound at 78.95 pence.
Earlier, the BoE slashed inflation and growth forecasts in
its Quarterly Inflation Report as the euro zone crisis continued
to take a toll.
Prior to Wednesday, the euro had rallied, in tandem with
stock markets and riskier currencies, following a pledge by ECB
President Mario Draghi last week to save the euro from
disintegration.
Market players have so far been unwilling to test the ECB's
resolve, and some banks have forecast the euro will push higher
over the coming weeks.

STERLING RISES
Sterling reversed earlier losses against the dollar to hit a
session high of $1.5677. It was last up 0.3 percent at
$1.5657. Traders had sold the pound in recent days on
expectations that downbeat BoE forecasts would lead speculators
to position for more monetary easing.
But the report suggested the BoE was in no hurry to provide
more stimulus, causing those bets to be unwound and helping the
British pound, traders said.
The yen rose as global stock markets came under pressure and
investors sought safe-haven assets and currencies. The euro
fell 0.5 percent to 96.98 yen while the dollar was
down 0.2 percent at 78.41 yen.
The dollar has stayed in a range between 77.90 and 78.80 yen
for the past two weeks. But analysts said expectations of more
U.S. monetary easing may hurt the dollar.
Boston Federal Reserve Bank President Eric Rosengren, who is
known to favor a more activist approach to stimulating growth,
said on Tuesday the Federal Reserve should launch another
bond-buying program of whatever size and duration was necessary
to get the economy back on its feet.
Traders also said there was potential for fund repatriation
by Japanese institutional investors, which could also weigh on
the dollar against the yen in the near term.
August typically sees large bond redemptions in U.S.
Treasuries as well as coupon payments, and traders say Japanese
investors holding Treasuries could potentially sell the dollar
against the yen to bring home some of the proceeds.