* Euro drops on QE comments from Bundesbank's Weidmann
* Dollar index firm but struggles to gain traction
* Latest US data fails to back up last week's dollar rally (Recasts, adds comments)
By Anirban Nag
LONDON, March 25 The euro fell broadly on Tuesday, after European Central Bank governing council member and Bundesbank chief Jens Weidmann said negative interest rates were an option the bank could use to counter strong gains in the single currency.
Weidmann also said it was not out of the question for the ECB to buy assets from banks to fight deflation, marking a radical softening of the German central bank's strict stance on quantitative easing.
The euro fell 0.2 percent to trade at $1.3808, having rallied on Monday on talk that a large sovereign investor may have bought the single currency as part of a reserve management exercise. Other traders attributed the gains to German companies repatriating profits from overseas.
It was also weaker against the yen and the British pound, though against a trade-weighted basket of currencies it remained still close to 2-1/2 year highs .
Weidmann's comments on sub-zero borrowing costs referred to negative deposit rates, which would mean that banks would have to pay to park their funds at the ECB overnight.
That would make it unattractive to hold euros while making the currency more liable to be used as a funding currency for investments in higher-yielding assets, depressing its value, analysts said.
Governing Council member Erkki Liikanen said on Monday the ECB was keeping a close eye on the euro to see how the exchange rate affected inflation, while European Commission vice-president for industry Antonio Tajani said on Tuesday that at $1.40 the euro was too strong.
"All the comments are a pre-emptive move by ECB officials to prevent a rapid appreciation beyond $1.40," said Ian Gunner, portfolio manager at Altana Hard Currency Fund. "It suggests that they are concerned about the euro but there is no consensus about future policy action."
Earlier in the day, the euro rose after mixed German data.
The German Ifo business morale index fell for the first time in five months in March, as expected, but current conditions sentiment edged higher, giving investors who had positioned for a weak set of readings an excuse to buy the euro.
"The Ifo survey was disappointing but only slightly," said Peter Kinsella, currency strategist at Commerzbank. "Business conditions remain robust, pointing to decent growth and a pick-up in wages. Typically the euro would have dropped if it was a very weak Ifo number. But it hasn't."
DOLLAR NEEDS DATA BOOST
The dollar index rose 0.1 percent to 80.065, having slipped the previous day in the wake of a disappointing reading on U.S. manufacturing activity.
It inched up after Philadelphia Federal Reserve President Charles Plosser told CNBC that Fed Chair Janet Yellen has not made a mistake about the timing of signals on possible rate hikes.
Investors had bought the dollar last week after Yellen suggested the possibility of raising interest rates early next year. But traders said the rally would not be extended unless it was supported by strong U.S. economic data.
Recent data has not been convincing enough despite offering hope that the world's biggest economy was picking up momentum after a weather-induced slowdown.
Later on Tuesday, the dollar could take fresh cues from a batch of U.S. economic data, including readings on consumer confidence and new home sales.
Against the yen, the dollar was steady at 102.30 yen, but stayed below Monday's high of 102.65 yen.
Meanwhile, the Chinese yuan consolidated gains against the dollar, a day after posting its biggest rise in nearly 30 months on speculation the Chinese government would unveil stimulus measures to support the economy. (Editing by Susan Fenton, John Stonestreet)