FOREX-Dollar gains on US rate outlook, China in focus

(Updates prices, adds quotes, changes byline)

By Gertrude Chavez-Dreyfuss

NEW YORK, May 21 (Reuters) - The dollar hit a five-week high against the euro and a three-month peak versus the yen on Monday as investors further trimmed bearish bets on the greenback amid a growing view the Federal Reserve may not cut interest rates this year.

Surprisingly strong U.S. data last week on housing starts, regional manufacturing, jobless claims and consumer confidence have helped the dollar rebound more than two cents from a record low against the euro hit last month.

"The dollar is doing well against the euro and yen and (is helped by) the Goldilocks scenario in the U.S., where's there's not too much worry about a hard landing," said David Powell, currency strategist at IDEAglobal in New York.

A "Goldilocks" environment describes an economy that is neither too hot that it causes inflation and nor is it too cold that it fuels a "hard landing" in recession.

The interest rate futures market showed last week a 64 percent chance of Fed easing in 2007. The stock market's continued strength and comments from Fed officials showing no real jitters about the economy or contagion from the subprime crisis have undermined prospects for Fed cuts.

"In terms of the dollar's performance against the euro, long euro/dollar has been a very crowded trade based on the specs (trading) data last week. Euro longs hit another record high and people are reluctant to bring it any higher without a fundamental story to back it up," he added.

By early afternoon in New York, the euro was down 0.3 percent on the day at $1.3464 EUR=, nearly 2 percent below a record peak hit last month. It fell as far as $1.3436 on electronic trading system EBS, the lowest since early April.

Suggesting that speculators' bets in favor of a stronger euro may have been getting overstretched, industry data last week showed the number of such positions had grown to a record high.

With little major U.S. economic data due this week, investors are further looking ahead to a meeting between U.S. Treasury Secretary Henry Paulson and China Vice-Premier Wu Yi on Tuesday and Wednesday in Washington where they are expected to discuss trade relations, including the value of the yuan.

The dollar was up 0.4 percent at 121.54 yen JPY=, after rising as high as 121.63. The Canadian dollar CAD=, however, continued to buck the trend, rising for the sixth of seven sessions to a near three-decade high against its U.S. counterpart.

The U.S. dollar was down about 0.3 percent at C$1.0846, as the Canadian currency continued to benefit from a recent run of strong economic data and persistent signs of overseas buying interest in Canadian firms.

Aside from U.S. data on durable goods and housing figures due late in the week, the market's attention this week is likely to be on China.

The U.S.-China meetings will be closely watched for any signs China is willing to let its currency strengthen more rapidly after last week's widening of the yuan's daily trading band against the dollar to 0.5 percent from 0.3 percent.

The Chinese currency CNY=CFXS firmed only marginally on Monday after the latest tweak to Chinese foreign exchange policy last week. But analysts agree a stronger yuan could help buoy other Asian currencies including the yen, which is the region's most liquid unit and is often traded as a proxy for the yuan.

Following China's move, Kuwait over the weekend switched to a basket system from a dollar peg. Analysts said the pressure for managed currencies to move toward a floating regime will only intensify.

"It will do so because countries can't cope with the liquidity created by fixed currency systems when the dollar is weak and it will also do so because there is political pressure from G7 -- particularly the U.S.," said Bear Stearns in a research note.