FOREX-Dollar rises as U.S. budget deal optimism wanes
* Euro falls vs firmer dollar as risk appetite fades
* Euro/yen pulls away from previous day's 18-month high
* Dollar/yen pauses after hitting 29-month peak
By Anooja Debnath
LONDON, Jan 3 (Reuters) - The dollar rose broadly and the euro fell on Thursday as optimism sparked by a deal to avoid steep U.S. tax rises and spending cuts gave way to concerns more budget wrangling could lie ahead.
The dollar index rose 0.1 percent at 79.883, having hit a three-week high of 80.088 in Asian trade.
U.S. lawmakers narrowly avoided the potentially recession-inducing tax hikes and spending cuts late on Tuesday, triggering a rally in equities and pushing down the dollar in favour of riskier and growth-linked currencies.
But the dollar, often favoured at times of market uncertainty, rebounded on Thursday as initial exuberance gave way to scepticism. Markets focused on the challenges ahead, with fresh talks on spending cuts and a rise in the limit on U.S. borrowing set for the next two months.
Analysts said this could lift the dollar in coming weeks.
"The reality is that budget talks will continue for the next two months and could get sour," said Jane Foley, senior currency strategist at Rabobank.
"There could be a messy two months ahead and we see the dollar index reclaiming some ground."
The euro was down 0.2 percent on the day at $1.3162, well below a peak around $1.3300 hit on Wednesday.
Traders reported offers up to $1.3175, though they also said central bank demand for euros was capping its fall.
The dollar rose to a three-week high against the Swiss franc of 0.92155 francs, with weak Swiss KOF sentiment data also weighing on the franc.
The low-yielding yen, which fell on Wednesday in the wake of the U.S. deal, edged up against the dollar but remained near a 29-month low and looked fragile on expectations the Bank of Japan will ease monetary policy further.
The dollar slipped 0.2 percent to 87.18 yen after rising as high as 87.36 yen earlier on Thursday on trading platform EBS, its highest since late July 2010.
"Technically dollar/yen looks somewhat overbought here. It's gone a long way in a very short time," said Callum Henderson, global head of FX research for Standard Chartered Bank in Singapore, adding that the dollar could see some consolidation in the near term before heading higher.
"Over the next few months, I think the bias is still for a higher dollar/yen rate," he said.
The euro also pulled away from an 18-month high against the yen of 115.995 yen on EBS on Wednesday and was down 0.4 percent on the day at 114.68 yen.
Over the past few weeks, the yen has weakened on expectations that a new Japanese government led by Prime Minister Shinzo Abe will push the BOJ into further monetary easing to beat deflation.
The yen is likely to remain vulnerable until the BOJ's policy meeting on Jan. 21-22.