FOREX-Dollar pares gains after Fed sweetens taper message
* Dollar hits 5-year high vs yen, later slips back
* Markets reassured by Fed message on interest rates
* Australian dollar near 3-1/2-year lows
* Euro just off almost two week low of $1.36495
LONDON, Dec 19 (Reuters) - The dollar struggled to hold onto gains on Thursday after the Federal Reserve surprised many analysts by announcing its long-awaited first cut in bond-buying but couched it by promising interest rates would stay low for longer.
A large majority of market watchers had expected the Fed to wait until next year before starting to reduce its stimulus for the economy but any impact on the dollar - which should in theory gain as a result - was tempered by the fact that much of the move had already been priced in by markets.
The Fed also said it "likely will be appropriate" to keep overnight rates near zero "well past the time" that the U.S. jobless rate falls below 6.5 percent - effectively extending the timeline for beginning to raise base interest rates.
The dollar jumped to a five-year high against the yen of 104.37 yen after the Fed decision before slipping back, and was recently at 104.17 yen. Traders said "short" bets on the yen falling were already stretched near to a maximum and that was also likely to check any dollar gains in the near term.
"The Fed took with one hand and gave with another," said Simon Smith, head of research at FxPro. "They sweetened the pill as much as they could. Tapering is not as dollar-positive as it would have been if it had happened in September."
Smith added that while he expected the dollar to strengthen next year, he did not expect it to hang onto these gains in the first quarter as fourth quarter GDP numbers slow compared with the third quarter.
Analysts were united in expecting the Fed's move, put off in September due to U.S. budget problems, but the central forecast before Wednesday had been for it to begin the tapering back of bond purchases in March.
The actual reduction in monthly asset purchases was minimal - $10 billion - and they remain at a staggering $75 billion a month in extra dollars that are coursing through global markets.
The euro lost ground against the dollar to hit its lowest in almost two weeks of $1.36495 as investors took profits from a recent rally.
But traders said there was plenty of support for it, both in the European Central Bank's rejection of short-term moves to ease its own monetary policy and the repayment of loans to the ECB by banks, which has squeezed the volume of available euros.
It was last trading back at $1.3671, also supported by news that the euro zone current account surplus hit a record high in October.
Implied volatility in euro/dollar options fell sharply on Thursday after the Fed's move. One-month implied volatility, a gauge of how sharp a currency move will be, fell to 6.1 percent from as much as 6.8 percent on Wednesday.
This implies the currency will trade within a range in the coming month.
The dollar has already risen 20 percent against the yen this year as the looming tapering contrasted with expectations the Bank of Japan would further loosen its own monetary policy.
Tapering is seen as positive for the dollar because it would push up Treasury yields and attract yield-seeking investors. But crucially two-year U.S. yields fell back on Wednesday after an initial rise as bond investors took reassurance from the Fed's message on interest rates.
"This (move by the Fed) really affirms our view of being dollar bullish," said Aaron Smith, managing director at currency hedge fund firm Pecora Capital. "We like the dollar, especially against the yen, as we go into 2014."
He said he expects a strong first half of 2014 for the dollar, which he sees rising to 108-112 yen.
The Australian dollar, already under pressure because of the central bank's desire to see it weaken, hovered near a 3-1/2-year low in the wake of the Fed's announcement.
The Aussie fell as far as $0.8820, its lowest since August 2010, and was last at $0.8859.
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