FOREX-U.S. dollar, yen fall as risk appetite returns

* USD falls against basket of currencies, yen also slips

* Federal Reserve creates commercial paper-buying facility

* Fed Chairman Bernanke to speak on Tuesday (Recasts, adds comments, updates prices, adds byline)

By Wanfeng Zhou

NEW YORK, Oct 7 (Reuters) - The U.S. dollar and the yen fell after the Federal Reserve on Tuesday acted to prop up the commercial paper market, boosting risk appetite.

Anxiety over the health of the global financial system had led investors to dump risky assets in recent sessions, sending the dollar to a 13-month peak against the euro and sparking broad gains in the yen on Monday.

The Fed said it set up a special-purpose facility with the Treasury Department's blessing to buy commercial paper in yet another emergency move aimed at calming chaotic financial markets. For more see [ID:nN07426060].

"It looks like they've decided to step in and relieve the pressure there. It's risky asset positive, so stocks like it and the yen crosses like it," said Brian Dolan, chief currency strategist at Forex.com in Bedminster, New Jersey.

In early trading in New York, the euro EUR= was up 1.4 percent to $1.3682, rebounding from a low of around $1.3444 hit on Monday, according to Reuters data, sparked by escalating worries about the health of European banks.

The ICE Futures U.S. dollar index, which tracks the greenback against a basket of six currencies, fell 1.1 percent to 80.766 .DXY.

Against the yen, the dollar rose 0.5 percent to 102.30 yen JPY=.

"The Fed announcement to act as a backstop in the CP market is likely to have a positive reaction in regard to sentiment," said Dustin Reid, senior currency strategist at RBS Greenwich Capital in Chicago.

"In terms of FX, it should help risk appetite on the margin, which is likely why we are seeing a USD selloff here."

The Fed move lessened the need for big cuts to benchmark lending rates, prompting a selloff in U.S. interest rate futures. This erased implied prospects for a possible 75 basis-point cut by the Fed in benchmark overnight U.S. interest rates at its next monetary policy meeting this month, and pushed chances for a 50 basis-point cut as low as 86 percent. One percentage point equals 100 basis points.

BERNANKE AWAITED

The highlight of the day will be Fed Chairman Bernanke, who will speak about the economy and financial markets to the National Association for Business Economics at 1:15 p.m. (1715 GMT).

Analysts said investors will scrutinize Bernanke's comments for clues about the likely direction of U.S. interest rates.

"Obviously, the big news overnight was the surprise 100-basis-point rate cut from the Reserve Bank of Australia which appears to have fostered some speculation that we're going to see a round of interest rate easing from major central banks in the very near future," said Stephen Malyon, senior currency strategist at Scotia Capital in Toronto.

"The Fed is being included in this speculation," he said. "I think that makes Bernanke's speech today particularly timely and important because he's either going to encourage or potentially discourage Fed easing expectations ..."

Currencies were whipsawed, hovering between extreme anxiety over the global banking system and hopes that governments would deliver a credible solution to the financial crisis.

Overnight, sterling hit a 2-1/2-year low against the dollar on renewed fears about the British banking system.

Sterling GBP= fell as low as $1.7322, its weakest since April 2006, but recovered to trade up more than 1 percent at $1.7608. (Additional reporting by Steven C. Johnson and Gertrude Chavez-Dreyfuss; Editing by James Dalgleish)