* Euro trades firm, holds just below two-year high against dollar
* Fed meeting could fuel more dollar selling
* Emerging market currencies seen vulnerable
* Dollar/yen edges up, rate differentials underpin pair
By Julie Haviv
NEW YORK, Oct 28 (Reuters) - The dollar edged higher on Monday but held close to a nine-month low against a basket of currencies, with most investors convinced that the Federal Reserve will maintain its ultra-loose monetary policy this week and in the months ahead.
The Federal Open Market Committee, the Fed’s policy-making arm, is unlikely to make any shift to policy at its meeting on Tuesday and Wednesday as the Fed awaits more evidence of how badly Washington’s budget battle has hurt the U.S. economy.
Many economists believe the Fed could stand pat for the rest of the year. Most expect the central bank not to begin withdrawing its $85 billion per month bond buying program until March 2014.
“It may turn out that a neutral FOMC is a green light to keep selling the dollar until November headline data begin appearing in early December, but as we note above there is already a lot of dovishness priced in,” said Steven Englander, global head of foreign exchange strategy at CitiFX, a division of Citigroup in New York.
The government shutdown interrupted data gathering in October, muddying the picture for Fed policymakers seeking signs on the economy’s strength. Economic data released since the shutdown ended has been surprisingly weak.
“However, insofar as the Fed gives any hint that the market has swung too far in the direction of ‘QE forever’, there will be risk for emerging market (currencies) and in particular for the high yielders that investors have bought back with a passion over the last month,” Englander said.
The dollar index, which tracks the greenback against a basket of six major currencies, last traded up 0.2 percent at 79.308 after earlier falling as low as 79.154, not far from a near nine-month low of 78.998 touched on Friday.
The longer the Fed keeps its policy loose, the more U.S. yields stay anchored, making the dollar less attractive to hold.
The central bank’s policy-setting committee is to release a statement on its policy decision on Wednesday, at the end of its two-day meeting, at 2 p.m. (1800 GMT).
The implied yield on the Fed funds futures contract for December 2015 has fallen from a recent peak of 1.45 percent to 0.65 percent, highlighting that investors have scaled back rate hike expectations in 2015 and beyond.
To spur growth, spending and hiring, the Fed has held overnight rates near zero since late 2008 and has quadrupled its balance sheet to around $3.7 trillion through three massive rounds of bond buying in a further effort to keep borrowing costs low.
Meanwhile, in thin trade, the euro traded down 0.1 percent at $1.3786, having risen to $1.3832 on Friday, its highest since November 2011, according to Reuters data.
Investors are a bit wary of pushing the euro much higher, however, worried that policymakers at the European Central Bank may try to talk down the currency in coming days.
Speculation that ECB policymakers may talk down the euro has gained pace especially after recent economic data, including German business confidence and purchasing managers’ index surveys, highlighted the fragile economic recovery.
“Eurozone policymaker concern is probably the biggest restraint for a euro/dollar that looks technically mobile toward the $1.3980/4000 area,” said Tom Levinson, currency strategist at ING. “The dollar index looks primed for a test of support in the 78.60/90 area in coming days.”
While the dollar is likely to struggle against the euro and the British pound, it is likely to gain ground against the yen. The dollar rose 0.3 percent to 97.70 yen, edging away from a more than two-week low of 96.92 yen hit on Friday.
The dollar was supported by the view that yield differentials between Japanese government bonds and U.S. Treasuries will persist, as the Fed eventually moves toward tapering while the Bank of Japan keeps its ultra-easy stance.
The BOJ is widely expected to maintain its monetary policy stimulus at its policy review on Thursday to meet its target of two percent inflation in two years.