FOREX-USD on the defensive as Fed outcome looms
* Dollar index falls to two-month lows
* Markets eye Fed meeting outcome due 1800 GMT
* China manufacturing data around 0100 GMT also in focus
By Ian Chua
SYDNEY, May 1 (Reuters) - The dollar languished at a two-month low against a basket of currencies in early Asian trade on Wednesday as investors wagered the U.S. central bank will recommit to its aggressive stimulus programme, with a chance of expanding it even.
The dollar index was at 81.701 , having shed more than 0.5 percent at one stage to a low of 81.598. The break below 81.744, the 38.2 percent retracement of its January-April rally, has opened the way to 81.204, the 50 percent retracement level.
Dollar bears shrugged off a rise in U.S. home prices and a rebound in U.S. consumer confidence, focusing instead on an unexpected contraction in Midwest business activity.
The data came as Federal Reserve policymakers gathered for a two-day meeting amid talk the central bank might have to add more stimulus to help widen a still patchy economic recovery.
"We see the risks as titled on the dovish side as the Fed is now effectively falling short on both its employment and inflation objectives," said Vassili Serebriakov, strategist at BNP Paribas.
"We expect this week's meeting to support our view that no QE3 tapering is likely until year-end and that the risk is for more, not less, easing."
Serebriakov said such an outcome would support the view that the U.S. dollar will be used as a key funding currency for risk trades, along with the yen.
The dollar drifted lower on the yen to 97.43, but remained not far from a 4-year high near 100 reached last month. The yen had been under intense pressure thanks to the Bank of Japan's own radical stimulus programme.
The greenback lost ground against the euro, which climbed to a two-week high near $1.3187. The common currency now faces tough resistance around $1.3200, a level that capped it last month.
The euro's strength was surprising as euro zone data has been just as disappointing as that from the U.S. and added to pressure for a cut in interest rates by the European Central Bank on Thursday.
Among the best performers, the Australian dollar extended its gains to a two-week high of $1.0386. It was last$1.0366.
The Aussie appeared to be gearing up for another go at stiff resistance seen near $1.0400, an area containing several key chart levels including the 50 percent retracement of its April 11-23 decline.
Traders said only an upside surprise in China's manufacturing data, due at 0100 GMT, will give the Aussie enough momentum to break higher. China is Australia's single biggest export market.
However, chances are slim given a preliminary report by HSBC last month showed growth in China's vast factory sector dipped in April as new export orders shrank.
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