FOREX-Euro drops first time in 4 days but Fed could limit downside

* Euro edges lower vs dollar after Friday's rally
* Fed monetary easing speculation weighs on dollar
* Investors await Dutch election, German court ruling

By Julie Haviv
NEW YORK, Sept 10 (Reuters) - The euro fell against the
dollar for the first time in four days on Monday, a reversal
that may prove to be transitory given high expectations that the
U.S. Federal Reserve this week will unveil new stimulus measures
to bolster the economy.
The euro remained close to an almost four-month high touched
on Friday when disappointing U.S. jobs data spurred speculation
the Fed would launch a third round of quantitative easing,
called QE3, at the conclusion of its two-day meeting on
Thursday.
Under the QE program, the Fed prints money to buy bonds,
which depresses Treasury yields, encouraging investors to seek
higher returns elsewhere. An increase in the money supply erodes
the value of the dollar.
"The Federal Reserve is gearing up to ease and the only
question is how far will they go," said Kathy Lien, managing
director at BK Asset Management in New York. "How far they will
go will depend on how aggressive they want to be but either way
we don't expect the central bank to stand by idly and do nothing
this week just because of the U.S. elections."
Lien said she expects the Federal Open Market Committee, the
Fed's policy making arm, to alter the rate guidance language of
its statement and extend the low rate pledge from 2014 to 2015.
The euro last traded down 0.1 percent at $1.2792,
below the session peak of $1.2812 and not far from Friday's peak
of $1.2817, which was its highest level since May.
Sentiment toward the common currency has improved as a
result of European Central Bank, which last week unveiled a plan
to cut borrowing costs for its most indebted countries.
But analysts cautioned that with Dutch elections and a
German constitutional court ruling on the euro zone permanent
bailout fund also due this week, investors would be wary of
pushing the currency much higher.
Westpac said in a note the euro may rise to $1.30 in the
near term after last week's soft U.S. jobs report bolstered
expectations of more easing by the Fed.
Westpac also said risks around the German constitutional
court's pending decision on whether the rescue fund can go ahead
were exaggerated. It expected a favorable ruling on the fund,
albeit with restrictions. Dutch election risks were also waning
as recent polls showed a tilt back toward pro-European parties,
all of which could see the euro target $1.33-1.34, it added.
Even so, analysts said the currency remained vulnerable to
developments in Spain, which may have to ask for a bailout, and
Greece, whose foreign lenders rejected parts of an austerity
package prepared by the government.
Greece acknowledged on Monday it was having trouble
persuading foreign lenders to accept a plan to save nearly 12
billion euros over two years, essential to unlocking aid
payments the country needs to avoid bankruptcy..

DOLLAR UNDER PRESSURE
In a Reuters poll taken after Friday's jobs report,
economists saw a 60 percent chance of the Fed embarking on QE3
this week compared with 45 percent in a late August poll.

More stimulus from the Fed would make it attractive for
investors to use the dollar as a funding currency to buy
higher-yielding assets in carry trades.
Expectations of Fed easing have helped the Australian
dollar, which hit a two-week high on Friday, but weak Chinese
trade data put it under some pressure on Monday.
The Aussie dollar tends to be sensitive to economic data from
China, Australia's biggest export market.
Against the yen, the U.S. dollar was steady at 78.24 yen
, just above a one-month low of 78.00 yen hit on Friday.
Analysts said Japanese authorities may start stepping up
their rhetoric against the yen's rise if the dollar drops below
the early August low of 77.90 yen. There was also a risk the
Bank of Japan could ease policy when it next meets to neutralize
some of the impact from possible action by the Federal Reserve.
Either move would be negative for the yen.
"We remain of the view that in the current more favorable
market environment and on a risk-reward basis, building long
dollar/yen positions on pull-back close to the 78.00 mark is an
appealing strategy," BMO Capital Markets said in a note.