FOREX-Dollar edges lower after Yellen, euro awaits ZEW

(Updates price, adds quotes, changes dateline, byline)

By Natsuko Waki

LONDON, March 14 - The dollar hit a one-week low against the euro and edged down versus the yen on Tuesday ahead of closely-watched U.S. data later as a key Federal Reserve official warned of raising interest rates too far.

The euro, which drew support this week from expectations for more buying from central banks, held firm ahead of a German ZEW investor sentiment survey for March.

San Francisco Fed President Janet Yellen said late on Monday that policymakers needed to weigh the risk of raising rates too far, and suggested she was comfortable with the outlook for inflation, although it was running near the top of the Fed's comfort zone.

Any signs that the Fed's tightening cycle is near an end would likely hurt the dollar, especially with the European Central Bank set to raise interest rates again, and even the Bank of Japan is seen nudging up rates by late in the year.

"Some people interpreted Yellen's comments as little bit dovish," said Johan Javeus, currency strategist at SEB in Stockholm.

"But she is not closing the door for future rate hikes as she is allowing incoming data to decide."

By 0835 GMT the euro had risen to a one-week high of $1.1985 <EUR=>, up 0.1 percent on the day. But it was still in a broad $1.18-$1.23 range held since December.

The dollar was down a quarter percent at 118.53 yen <JPY=>, and down 0.2 percent at 1.3092 Swiss francs <CHF=>.

U.S. February retail sales data are due at 1330 GMT, expected to show a 0.8 percent fall after a 2.3 percent rise in the previous month.

U.S. consumer prices data are due on Thursday.

The Fed is expected to raise rates by 25 basis points to 4.5 percent when it meets later this month -- the first under Fed chief Ben Bernanke, extending a streak of 14 straight rate rises since mid-2004.

The U.S. cost of borrowing is expected to reach at least 5 percent by mid-year.

EURO BOOSTED

The euro drew support on expectations of European Central Bank tightening and after the United Arab Emirates' central bank said it was considering putting more of its reserves -- estimated at around $23 billion in December -- into euros.

Currency traders were also looking ahead to the ZEW survey of German investor sentiment due at 1000 GMT.

The headline index is expected to come in near a two-year high, which could add to expectations that the ECB will keep raising interest rates after two quarter-point rises since December.

In contrast the BOJ is widely expected to keep short-term rates pinned near zero until late in the year, even after the central bank abandoned its five-year-old ultra-easy monetary policy last week.

The Japanese bond market is factoring in the inevitability of higher rates in Japan, with short-term government bond yields surging to fresh 5-year highs this week and rate futures pricing in two quarter-point rate rises by the BOJ by year-end.

While the yen was unable to capitalise significantly on last week's BOJ policy shift, market participants said that the door to rising rates had swung open and that this was one of the biggest risks to dollar/yen trading.

"If you think about what has changed in the market from last year, the new factor is the possibility that Japanese rates may start to rise, so there's more room for the yen to appreciate," said Nobuo Ibaraki, foreign exchange manater at Nomura Trust and Banking in Tokyo.

The New Zealand dollar was the biggest mover on Tuesday, sliding as much as 1.1 percent against the U.S. dollar after a surprisingly weak retail sales report added to worries that the kiwi's rate premium was set to erode.

The kiwi was trading at US$0.6345 <NZD=>, after hitting a 20-month low of $0.6323 and bringing its losses this year to more than 5 percent.