* Dollar up broadly in aftermath of Fed discount rate hike
* Unexpectedly low CPI data take some steam out of rally
* Euro near 9-month lows, dollar rises 1 pct vs yen (Adds details, updates prices)
By Vivianne Rodrigues
NEW YORK, Feb 19 (Reuters) - The dollar rose broadly on Friday, touching an eight-month high against a currency basket, boosted by the Federal Reserve's decision a day earlier to raise the interest rate it charges banks for emergency loans.
The Fed said late on Thursday it raised the discount rate to 0.75 percent from 0.50 percent, effective Friday, although it left the benchmark federal funds rate, its main policy tool, unchanged near zero. For more see [ID:nSGE61I036].
Currency markets took the decision as a signal the U.S. central bank was coming closer to tightening its benchmark rate despite assurances from Fed policymakers to the contrary.
The announcement triggered a rally in the greenback as higher rates increase the return on dollar-denominated assets.
"The markets are taking this as a clear step towards normalization in monetary policy," said Meg Browne, a currency strategist at Brown Brothers Harriman in New York.
"If you combine the Fed actions with the fundamentals of the U.S. economy and contrast it with the situation in Europe, dollar buying is more than justified."
In midday trading in New York, the dollar was up 0.8 percent versus a basket of currencies at 81.042 .DXY after rallying to an eight-month high of 81.342, according to Reuters data.
The euro EUR= traded as low as $1.3444 according to Reuters data, its lowest in nine months.
The euro zone common currency recovered some of its losses after a U.S. government report showed consumer prices rose less than expected in January. [ID:nN18218950]
Analysts said tame U.S. inflation may support the view that benchmark U.S. interest rates will be low in the foreseeable future, taking some steam out of the dollar's rally.
"That type of data reinforces the outlook for low U.S. interest rates," said Joe Manimbo, a currency trader at Travelex Global Business Payments in Washington.
"Consequently the dollar has pared some of its impressive overnight gains."
Against the dollar, the euro was last 0.7 percent lower at $1.3521 and on track for its sixth consecutive week of declines. The dollar rose 0.9 percent to 91.99 yen JPY=.
"Even though this is not an official tightening, it shows that the Fed is at least 'moving'. The Bank of Japan may require more quantitative easing and the ECB cannot change its stance, so the dollar can rally further against the yen and the euro," said Antje Praefcke, currency strategist at Commerzbank.
The dollar gained over recent weeks on the back of positive U.S. economic data while structural problems in the euro zone have weighed on the euro, prompting it to fall more than 5 percent against the greenback since the start of the year.
While the timing of the Fed's discount rate announcement surprised the market, Fed Chairman Ben Bernanke had said last week the central bank could soon raise that rate. He stressed that the move would not be akin to tightening monetary policy.
St. Louis Fed President James Bullard said investors' belief in the high probability of a rise in the Fed's benchmark federal funds rate this year was 'overblown' and that the discount rate rise should not be seen as a policy signal.
Another Fed policy-maker, Dennis Lockhart, voiced a similar view. [ID:nN18242630]
The Australian dollar extended losses despite hints by Reserve Bank of Australia Governor Glenn Stevens that further interest rate rises were likely. [ID:nSGE61H03Z]
The Aussie fell 1 percent to $0.8932 AUD=D4 and shed 0.7 percent against the yen to 81.63 yen AUDJPY=R.
Sterling also remained under pressure, dropping to as low as $1.5345 versus the dollar GBP=D4 as the pound struggled after weak British retail sales data. [ID:nONS004813] (Additional reporting by Wanfeng Zhou in New York and Neal Armstrong in London; Editing by James Dalgleish)