FOREX-Dollar edges up vs euro, but more weakness seen

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By Toni Vorobyova

LONDON, March 27 (Reuters) - The dollar edged up against the euro on Thursday but was still on track for the worst quarterly performance since late 2004 as investors compared relative economic resilience in the euro zone with a sharp U.S. slowdown.

Demand for the U.S. currency as the end of the first quarter looms gave the dollar some short term support after two days of steep losses on contrasting U.S. and euro zone data.

"There was quite a strong rally in euro/dollar yesterday and it seems that the market got caught a bit short dollars, so now there is a slight recovery, and there is some extra funding demand for dollars into quarter end," said Geoffrey Yu, currency strategist at UBS in Zurich.

"But if we are going to see a real dollar recovery than we are going to need to see at least one good piece of U.S. data and a sell-off in commodities, and at the moment it doesn't look like that's going to happen."

U.S. data so far this week has added to the picture of an economy on the verge of recession, with March consumer confidence plunging to a 5-year low, a surprise fall in February durable goods orders and a record drop in home values in January.

In the eurozone, meanwhile, expectations of a near-term interest rate cut have been erased by forecast-beating German and French business confidence surveys and continued hawkish rhetoric from the European Central Bank.

ECB President Jean-Claude Trichet said on Wednesday euro zone rates were at the right level and stressed inflation risks.

"What we saw yesterday after the (German) Ifo and the hawkish (ECB) comments seems to have given the green light for euro/dollar," said Anders Soderberg, strategist at SEB Merchant Banking in Stockholm.

He added that Thursday's correction would likely be contained above the $1.5680 level, before another leg higher towards the psychologically key $1.60 mark.

The euro EUR= was down 0.7 percent on the day at $1.5734, nearly two cents below last week's record highs above $1.59, but still up 7.8 percent this quarter -- on track for its strongest quarterly performance since the last three months of 2004.

The euro had surged 2.7 percent combined on Tuesday and Wednesday, its biggest two-day rise against the dollar since January 2001, when the Fed started slashing rates to contain the last U.S. recession.

French government spokesman Luc Chatel said that too strong a euro can have negative effects on the French economy and that France has made that point to the European Central Bank.

The Chief Executive of EADS (EAD.PA), whose Airbus unit faces stiff competition from U.S.-based Boeing, said that the strong currency is stifling European industry.

However ECB policymakers still seem reasonably comfortable with the exchange rate, stressing that excessive FX volatility is a bad thing, but at the same time highlighting the bank's inflation-fighting mandate. From that perspective a strong currency is actually a boon as it reduces the price of exports.

BRIEF RECOVERY?

The dollar also recovered some of its recent falls versus other major currencies. It gained around 1 percent to 0.9979 Swiss francs, hovering just below parity through which it slipped for the first time two weeks ago CHF=, and rose to 99.74 yen JPY=.

Strong performance in equity markets helped boost risk appetite, propping up the dollar to the detriment of the low-yielding yen and safe-haven Swissie.

The U.S. currency's sharp falls have made it vulnerable to abrupt swings higher in bouts of profit taking, resulting in jittery, volatile markets.

However analysts reckon that in the short-term at least, the broad trend will remain for more dollar weakness.

The U.S. Federal Reserve has slashed the benchmark fed funds rate to 2.25 percent from 5.25 percent just over six months ago, while the ECB has kept rates steady at 4 percent.

U.S. short-term interest rate futures now indicate investors see around a 40 percent chance of the Fed cutting interest rates by 50 basis points in April. A 25-basis-point rate cut is fully priced in. FEDWATCH

The final reading of U.S. fourth quarter growth is due at 1230 GMT, along with the weekly jobless data.

"Weak result of jobless claims and/or dovish Fed commentary should heighten the speculation on a 50 bps cut, resulting in further USD decline," JP Morgan said in a research note.

(Editing by Gerrard Raven)