Dollar falls ahead of expected Fed rate cut

NEW YORK (Reuters) - The dollar slipped against most major currencies on Monday for the third consecutive session, a day ahead of a widely expected Federal Reserve interest-rate cut, aimed at staving off a recession.

Futures fully reflect a quarter-percentage-point easing in the fed funds rate to 4.25 percent from 4.50 percent. But chances of a bigger move have fallen to one-in-five from around one-in-two a week ago because of a string of somewhat stronger-than-expected economic data.

"The market is front-running the expectation that the Fed is going to cut and we expect the dollar to remain pretty much weak before the FOMC (Federal Open Market Committee) decision," said Boris Schlossberg, senior currency strategist, at DailyFX.com in New York.

By early afternoon, the euro was up 0.4 percent at $1.4712. It got a boost last week as comments by European Central Bank President Jean-Claude Trichet left open the possibility of higher rates next year as a result of lingering inflation.

The New York Board of Trade's U.S. dollar index, which tracks the dollar's progress against a basket of six major currencies, fell 0.3 percent through several key technical levels to 76.076 .DXY.

The dollar was relatively unchanged against the yen, at 111.66 yen, above a 2-1/2-year low of around 107.20 yen hit last month.

Sterling rose 0.7 percent to $2.0455.

As recently as a few weeks ago, the dollar was supported by expectations of a half-percentage-point rate cut by the Fed, as dealers expected a kick start to the economy.

However, persistent tightness in credit markets and lower expectations for such a big rate cut have left the dollar back in a familiar downward trend.

"The risk is that, given current credit market conditions, Fed rate cuts might not be as stimulative as they otherwise would be," said Max Bubliz, chief strategist with SCM Advisors, in San Francisco.

"If the Fed is timid with rate cuts early in the easing cycle, more will surely be needed later," he said in a note.

Markets have recently pared back aggressive U.S. rate-cut forecasts, with analysts citing considerably more "optimism" that Fed action will be enough to prevent more severe fallout from market volatility.

A U.S. government plan unveiled last week to limit potential mortgage defaults also stirred hopes that the economy's downturn will be contained.

"We believe this confidence may be misplaced. Fed action thus far has done little to reverse underlying weakness in U.S. housing markets or offset financial market stresses," CitiFX said in its latest research note.

"Against this backdrop, it may be difficult for the Fed to contain volatility and there is likely significant scope for policy-makers to disappoint markets."

Meanwhile, central bank officials in the euro zone have given very few indications that they see the need for immediate stimulus and, if anything, are more concerned with upward price pressures.

Comments on Monday by European Central Bank Executive Board Member Juergen Stark saying euro-zone inflation could be higher in 2008 than indicated in the ECB's latest projections last week also bolstered the view that the bank is not likely to ease any time soon.

The euro was broadly higher. Against the yen, the euro rose 0.3 percent to 164.22 yen.

The euro climbed 0.3 percent higher against the Swiss franc to 1.6590 francs.

(Editing by Jan Paschal)