FOREX-Dollar hits two-week lows, yen gets safety bid

(Adds Merrill report, latest prices)

SYDNEY, Dec 31 (Reuters) - The dollar slipped to fresh two-week lows on Monday as talk of more U.S. interest rate cuts enhanced the euro's yield advantage, while the yen benefited from a reluctance to hold risky positions over the holidays.

In thin Asian trading, the euro was buying $1.4736 EUR=, compared to $1.4714 late in New York on Friday and just off a two-week high of $1.4747. The dollar also skidded to 111.97 yen JPY=, from 112.63 late on Friday.

The dollar was still smarting from weak U.S. new home sales data out on Friday which only added to speculation the Federal Reserve would have to cut rates further next year, perhaps several times.

As a result, two-year U.S. Treasury yields dived to 3.11 percent, far below comparable Euro yields of 4.0 percent.

Against a basket of six major currencies .DXY, the dollar eased 0.25 percent to 76.023. That came on top of a 1.9 percent decline last week, its worst weekly performance in over a year.

Credit concerns and geopolitical jitters also kept investors away from carry trades, where they borrow at low rates in yen and Swiss francs to buy higher-yielding currencies.

Traders noted a report in Britain's Observer newspaper which claimed Merrill Lynch MER.N needed more capital and was in talks with Chinese and Middle Eastern sovereign funds to sell more of itself.

Just last week, Merrill announced a $6.2 billion capital infusion from Singapore's government and money manager Davis Selected Advisers.

"This Merrill report is doing the rounds and having a depressing effect on the dollar, especially with the market so illiquid," said one trader at a local bank.

"It's another reason not to be short of the yen over the holidays," he added, noting Tokyo was off until Friday.

Instability in nuclear-armed Pakistan after the assassination of opposition leader Benazir Bhutto had also prompted investors to cut back riskier positions and buy save-haven assets like gold, Treasuries and the Swiss franc.

The dollar was pinned down at 1.1238 Swiss francs CHF=, after a 1.1 percent drop on Friday, while gold climbed further to 842.00 an ounce XAU=.

"It's been a tough quarter for most fund managers, so it's no surprise they don't want to hold aggressive positions over the holiday," said Peter Pontikis, Treasury strategist at Suncorp Metway.

"Then again, fund managers are sitting on an awful lot of cash right now and they'll have to put that to work in the new year," he added. "We suspect much of it will end up in U.S. assets which have been beaten down so far that they have to be tempting on a long-term view."

That could boost the U.S. dollar in coming weeks, particularly against the euro and Canadian dollar, argued Pontikis. The dollar could do with the help. Figures from the IMF late on Friday showed the dollar's share of known official foreign reserves fell to 63.8 percent in the third quarter, down from 66.5 percent in the same three months of 2006.