FX OUTLOOK-Dollar set to gain, decoupling view challenged

By Lucia Mutikani

NEW YORK, Aug 8 (Reuters) - The dollar could rally further next week amid signs the sluggishness gripping the U.S. economy is spreading to other regions and the commodity boom might have peaked, diminishing prospects of higher interest rates outside the United States.

Mounting evidence of slowing growth in Europe, Asia and Australia have buoyed the dollar, whose yield appeal has been eroded by the Federal Reserve's aggressive cuts in a bid to prevent a housing recession from seeping into the broader economy.

The dollar surged to a five-month high versus the euro and scaled a five-and-a-half month peak against a basket of six currencies on Friday. The euro dropped as low as $1.5006.

Analysts saw more gains next week, with data expected to show the euro zone economy shrunk in the second quarter.

"The shift in dollar sentiment that we have seen is quite significant," said Vassili Serebriakov, currency strategist at Wells Fargo in New York.

"What we are seeing is not necessarily that the U.S. economy has started to perform in a stellar fashion or that there is a surge in the demand for U.S. dollars. What has happened is a major shift for the worse elsewhere," he said.

Analysts reckon slowing global growth will push crude oil prices even lower, leaving central banks that have maintained an inflation vigil with no reason to tighten monetary policy.

Oil prices have tumbled from a peak of over $147 a barrel last month to below $116 on Friday.

Meanwhile, that drop has improved prospects of the U.S. economy's recovery, and probably reduced the Fed's need to cut rates when other central banks are expected to start easing monetary policy to shore up growth, analysts said.

EASING BIAS

"We have gone from the decoupling theme that has been driving the dollar to recoupling. The rest of the world is now slowing down. In euro land you are also seeing a real pronounced slowdown that is taking shape," said Paresh Upadhyaya, portfolio manager at Putnam Investments in Boston.

"What is happening is that the markets are now anticipating that the G10 central banks are moving away from the tightening bias to an easing bias. That shift is what is having a positive impact on the dollar."

Confirmation of a deteriorating growth picture in the euro area could come from second-quarter gross domestic product (GDP) growth data, expected to show a 0.2 percent contraction after a 0.7 percent expansion in the first quarter.

Even if U.S. retail sales and capital inflows data were to disappoint next week, analysts reckon it would be insufficient to derail the dollar's rally.

"I do see the dollar maintaining its gains next week. A lot of negative news is already priced in," said Upadhyaya.

"Investors know that financial sentiment remains fragile, but U.S. has taken all the steps to restore stability to promote growth, the rest of the world has not."

Analysts also argued the dollar's breach of key technical levels suggested that more gains were in the pipeline.

"Euro/dollar may fall as low as $1.4920, which is not only below the 200-day moving average of $1.5220, but also a major previous resistance and now likely support," said Ashraf Laidi, chief market strategist at CMC Markets in New York.

July consumer inflation data will likely show price pressure remaining elevated, supporting the case for higher U.S. interest rates at some point. Consumers' confidence probably perked up slightly in August, data will also show.

Amid a raft of earnings, some of which may miss market forecasts and hurt U.S. stocks, analysts are cautious about the dollar's prospects against the yen.

"Dollar/yen is vulnerable to any bout of risk aversion, but looking at the technical picture it looks like we are heading higher. We are looking at 110.50 as the next level to watch," said Wells Fargo's Serebriakov.

Companies reporting their results next week include mass retailer Wal-Mart Stores (WMT.N). (Editing by Andrea Ricci)