FOREX-Dollar helped by Fed's QE doubts, euro clings to key support
* Fed debate on scaling back QE helps to lift U.S. dollar
* Euro hit by weak euro zone PMI data
* Euro tries to defend 50 pct retracement of Nov-Feb rally
* Yen likely to post 1st substantial weekly gain in 3 months
* Pound under pressure on BoE expectations
TOKYO, Feb 22 (Reuters) - The dollar dangled near a 5-1/2-month high against a basket of currencies on Friday, helped by doubts over just how long the U.S. Federal Reserve will keep its quantitative easing in place.
The euro tumbled to a six-week low against the dollar on disappointing euro zone economic data and uncertainty ahead of Italy's election this weekend, though the common currency managed to hold above a key retracement level.
The dollar index, which measures its value against a basket of six major currencies, dipped 0.2 percent to 81.265, having gained 0.8 percent so far this week after having risen as high as 81.508 on Thursday, its highest level since Sept. 5.
Minutes of the Federal Reserve's last meeting, released on Wednesday, and comments from the bank's two top officials on Thursday showed growing internal debate about scaling back its bond buying programme.
Concerns that the Fed may stop providing a flood of cash to banks boosted the dollar, at the expense of many other assets, ranging from the euro and other risk currencies to stocks and commodities.
The euro fell to a six-week low of $1.31615 on Thursday but recovered slightly in Asia to trade at $1.3212, up 0.2 percent from late U.S. levels.
Business activity indexes dealt a blow to hopes that the euro zone might emerge from recession soon, showing the downturn across the region's businesses unexpectedly worsened this month.
The data raised nervousness ahead of an influential German Ifo business sentiment index due at 0900 GMT on Friday.
"After the euro's fall yesterday, we should be wary of risk that weak Ifo figures cement concerns on the euro zone economy. Given that the euro had been outperforming since late last year, its correction could be large," said Junya Tanase, chief FX strategist at JPMorgan Chase Bank.
In addition, the anxiety that Italy's national election this weekend could lead to a fragmented parliament and a weak government capped the euro.
But some market players think the euro is more likely to see a relief rally after the election, expecting Pier Luigi Bersani's centre-left bloc will ally with a centrist group led by Prime Minister Mario Monti to form a stable government.
"The euro is capped now ahead of the Italian election but once that uncertainty will have been cleared, the euro is likely to rebound," said Kyosuke Suzuki, director of foreign exchange at Societe Generale.
The currency is now trying to cling to an important chart point of $1.3186, a 50 percent retracement of its 10.5-cent rally from November to February.
Below that is another major support from its 90-day moving average, at $1.3135, though a break there will leave it open for a test of the Jan. 10 low of around $1.3040.
NO FOREIGN BOND BUYING
While the dollar gained across the board, the U.S. currency failed to advance much against the yen as the Japanese currency's three-month-old decline on monetary easing expectations is showing signs of losing momentum.
The dollar stood little changed at 93.28 yen, keeping some distance from its 33-month high of 94.47 hit last week.
"Judging from recent comments, most Japanese ministers don't really wish to push the dollar/yen up beyond 95 yen. I suspect if the yen weakens further, (Finance Minister Taro) Aso will try to rein in the yen's fall," said Minori Uchida, chief strategist at the Bank of Tokyo-Mitsubishi UFJ.
The yen looks set to post its first substantial weekly gain since mid-November, when the announcement of a Japanese election spurred investors to bet more political pressure would be put on the Bank of Japan to take bold easing steps.
Speculators turned their gaze to the British pound, which has fallen about 1.5 percent so far this week, hitting a 2 1/2-year low of $1.5130 on Thursday, on expectations of more quantitative easing by the Bank of England.
Sterling has recovered a little to last trade at $1.5254 but it is still seen as vulnerable.
The Canadian dollar flirted with a seven-month low versus the U.S. unit hit on Thursday, trading at C$1.0165 per U.S dollar, near Thursday's low of C$1.0208.
The Australian dollar recovered, however, after hitting four-month low on Thursday, after the Reserve Bank of Australia's (RBA) chief said there was already a good deal of policy stimulus in the economy, prompting markets to further widen the odds of an easing next month.
The Aussie rose 0.7 percent to $1.0315, after having hit a low of $1.0221 on Thursday.
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