September 26, 2013 / 8:23 PM / 4 years ago

FOREX-Dollar climbs but U.S. budget cliffhanger limits upside

* Dollar gains despite wariness over possible U.S. gov't shutdown

* Euro hurt by Italy's renewed political tensions

* Barclays expects dollar to trade sideways with downward bias near term

* Yen drops on Japan corporate tax-cut hopes

By Julie Haviv

NEW YORK, Sept 26 (Reuters) - The dollar gained broadly on Thursday, recouping losses from the previous session, after stronger-than-expected U.S. weekly jobless claims data favored the view that the Federal Reserve will wind-down is stimulus program this year.

The dollar's upside, however, could be limited in the near term as worries about a potential U.S. government shutdown and the possibility of a debt default are keeping investors cautious.

Republican lawmakers in the U.S. House of Representatives refused to give in to President Barack Obama's demands for straightforward bills to keep the government running beyond Sept. 30.

House Republicans also challenged Obama on the debt ceiling increase, the amount the government is allowed to borrow, which the Treasury Department has said is urgently needed by Oct. 17.

In late afternoon trading, the dollar was up 0.3 percent against a basket of currencies at 80.554, above a seven-month trough of 80.06 hit on Sept. 18.

The dollar was buoyed by weekly data showing the level of initial U.S. jobless claims came in much better than expected, with a fall to a near six-year low, suggesting a steadily improving labor market.

The reading gave a clearer view of the labor market after the number of claims earlier in September may have been distorted as two states updated their computer systems.

"Surprise improvement in America's job market pulled the dollar higher and revived market bets on a Fed taper at a coming meeting," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington.

The data was particularly encouraging ahead of next week's nonfarm payrolls report for September, he said.

"A better pace of monthly hiring, if realized, would strengthen the case for the Fed to slow stimulus at its next meeting on Oct. 29-30, and ease a big burden on the dollar," he added.

The greenback on Thursday was also helped by the euro's fall amid renewed political uncertainty in Italy, the bloc's third-largest economy.

Italian center-right deputies supporting former Prime Minister Silvio Berlusconi renewed threats to resign if their leader is expelled from Parliament following a tax fraud conviction.

The euro last traded down 0.3 percent at $1.3484.

The dollar earlier rose as high as 99.13 yen on a media report that Japan's government plans to say it will "urgently consider" cutting the corporate tax rate when it compiles a stimulus package next week.

A government source told Reuters last week that Japan will consider cutting corporate taxes and ending a temporary tax hike earlier than scheduled, to cushion the economy from a scheduled sales tax increase.

That would add up to more stimulus than previously expected for the economy, which is negative for the yen, helping push Japan's benchmark Nikkei stock index higher.

Against the yen, the dollar was last up 0.4 percent at 98.84 yen, according to Reuters data.

The dollar has struggled since the Fed stunned markets last week by deciding not to scale back its massive stimulus program for the time being, which has raised the question of whether markets have been too optimistic on the state of the U.S. economy.

In another criticism about how the Fed handled the decision, Fed Governor Jeremy Stein said the Fed - the U.S. central bank - should make itself more predictable about scaling back its stimulus campaign. He maintained the Fed had confused markets by not tapering at its meeting last week.

Stein said he would have been comfortable starting to reduce asset purchases at the Sept. 17-18 meeting, and that the decision to keep buying at an $85 billion monthly pace had been, for him, a "close call."

"The Fed's decision to postpone tapering delays, but does not derail, our constructive dollar outlook," Barclays Capital said in a report.

Barclays expects the delays to add $250 billion to the Fed's balance sheet and as a result, the bank expects the dollar to trade sideways with a downward bias in the near term.

Emerging market currencies have fared well from the Fed's bond-buying as investors have plowed cash into higher-yielding assets.

"For the first time in months, we think it is time to take profits on our short emerging market carry positions held since the start of the year," Barclays said.

The bank believes a broad-based dollar rally against the major currencies, including the euro, will have to wait until the Fed begins to taper, which the bank expects in December, or until growth trends in the United States and euro zone re-diverge.

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