* Dollar near two-week lows against a currency basket
* Euro/dollar and dollar/yen one-week implied vols jump
* Carney's comments lift sterling
By Anirban Nag
LONDON, Sept 12 The euro fell on Thursday after euro zone industrial output contracted in July, but the dollar failed to make much headway against a basket of currencies amid nervousness before next week's Federal Reserve meeting.
Sterling cut losses against the dollar and hit a session high against the euro after Bank of England Governor Mark Carney showed no apparent unease over rising bond yields.
With the threat of an immediate U.S. attack on Syria waning, the focus is on next week's Federal Reserve meeting, when the Fed is expected to kick start its stimulus withdrawal programme. But given that the U.S. jobs market is still not picking up pace, it may sound a dovish note.
The euro was down 0.15 percent at $1.3295, with the single currency hitting a session low of $1.3283 after the euro zone data showed industrial production fell 1.5 percent in July, compared with a 0.1 percent increase forecast.
The euro fell more sharply against the yen, falling 0.7 percent to 131.97 yen while against the pound, it was trading weak near a recent 7-1/2 month low.
The euro's losses should have lifted the dollar index . But it was flat on the day at 81.524, not far from a two-week low of 81.410 struck earlier in the session.
"Going into the Fed meeting, people are wondering how much tapering it will do," said Mankash Jain, head of FX and Investment Management, Solo Capital a London-based hedge fund.
"We are not going short dollars into the meeting and believe there is an upside. We are definitely not long euros, either, given the data from the euro zone isn't great."
Since last Friday's disappointing U.S. non-farm payrolls data, markets have tempered their expectations for any aggressive stimulus withdrawal by the Fed. That has led investors to trim long dollar positions built on expectations the Fed will unwind stimulus by a much larger amount.
That view was expressed in the dollar/yen pair which fell from a seven-week high of 100.62 yen hit on Wednesday to 99.40 yen, down 0.5 percent on the day.
"It looks like the Fed will only make a modest $10 billion tapering next week. So investors are adjusting their positions accordingly," said Jane Foley, senior currency analyst at Rabobank. "The Fed will be very careful with tapering and will probably only dip its toe."
NERVOUSNESS IN THE OPTIONS MARKET
Citi economists expect $10-15 billion of Fed tapering and no change to the withdrawal timetable, an outcome that Steven Englander, Citi's global head of G10 FX Strategy, said would be neutral, or even slightly hawkish, relative to expectations.
Reflecting the nervousness before the Fed meeting, euro/dollar and dollar/yen one-week implied volatilities - a gauge of how sharp price swings will be in the near term - shot up.
The one-week euro/dlr implied vol was trading at around 7.85 percent, much higher than the one-month implied vol which was at around 7.2 percent. The one-week dollar/yen implied vols were also trading above one-month implied vols.
While near term volatility in the currency market has picked up, stock markets have remained calm. The European stock market volatility index was lower while the Wall Street's favourite fear index, the VIX, ended down on Wednesday.