FOREX-Dollar falls broadly as Fed slashes interest rates

(Recasts; updates prices, adds quote, detail, byline)

By Steven C. Johnson

NEW YORK, Jan 30 (Reuters) - The dollar sank to a fresh two-month low against a basket of major currencies on Wednesday after the Federal Reserve cut benchmark U.S. interest rates by a half percentage point and warned that more would likely be needed to support the faltering economy.

The move comes just eight days after the U.S. central bank unexpectedly cut its benchmark lending rate by three quarters of a point to boost an economy battered by a deep housing slump and a persistent credit crisis.

"The language in the (Fed's) statement was fairly strong, suggesting the Fed is still worried with the possibility of further deterioration in the U.S. economy," said Mark Meadows, analyst at Tempus Consulting in Washington, D.C.

The cumulative 1.25 percentage point reduction brings rates to 3 percent, a full percentage point below euro-zone rates and among the lowest in the developed world.

Dealers reacted by pushing the New York Board of Trade's U.S. dollar index, which measures the greenback against a basket of six major currencies, to a two-month low .DXY. The euro surged 0.8 percent to $1.4906 EUR=, not far from its all-time high around $1.4967, according to Reuters data, before easing to $1.4881.

The dollar fell 0.1 percent against the yen to 106.90 JPY=.

The Fed cuts also encouraged investors to move back into high-yield, high-risk trades. Both the Australian AUD= and New Zealand NZD= dollars rose more than 1 percent against the greenback, while the U.S. currency fell 1 percent against the Canadian dollar CAD=.

Sterling lunged higher by more than a cent after the Fed move, up 0.2 percent to $1.9945 GBP=.

Traders said the market was watching to see whether the euro could build on its momentum to rise above $1.50, though some said it might take more tough talk from the European Central Bank on inflation.

Unlike the Fed, the ECB has held interest rates at 4 percent throughout a credit crisis that began in mid-2007, and policymakers have continued to focus on inflation risks.

STRIKING A BALANCE

Some economists have also worried about the inflationary impact of the Fed's aggressive easing campaign, especially given the dollar's weakness in recent months.

"This move is really designed to help financial markets even if it allows inflation pressures to pick up later on down the line," said Amo Sahota, president and head of global research at HiFX in San Francisco.

In fact, some analysts said the Fed's aggressive action now puts it ahead of the curve, adding the dollar may rebound if the U.S. economy starts to gain traction and avoids falling into recession.