Dollar pressured before Fed policy outcome

By Chikako Mogi

TOKYO (Reuters) - The dollar eased on Wednesday as investors warily awaited the outcome of the U.S. Federal Reserve's two-day policy meeting later, while the euro drifted on expectations for a rate cut when the European Central Bank meets later in the week.

Optimism over the U.S. recovery was the main driver behind this year's rallies in riskier investments, especially U.S. stocks, overshadowing weak spots emerging in China and the euro zone's deteriorating economy.

A report on Wednesday showed that growth in China's manufacturing sector unexpectedly slowed in April, with the official purchasing managers' index (PMI) falling to 50.6 from March's 11-month high of 50.9 as new export orders and input prices contracted.

The PMI was also below the 51 forecast, but stayed above the watershed mark of 50 for seven straight months. The 50 level separates expansion from contraction.

The Australian dollar hit a session low of $1.0365, but reaction was generally muted, largely as many Asian markets were closed for the Labour Day holiday and trading was thin.

MSCI's broadest index of Asia-Pacific shares outside Japan inched down 0.1 percent, retreating from Tuesday's seven-week high, and dragged down by a 0.3 percent fall in Australian shares which reached their highest in nearly five years in the previous session.

"It looks like China is in a situation where sluggish growth is going to continue for longer, which is not great from a commodities point-of-view," said Damien Boey, an equity strategist at Credit Suisse in Sydney. Australian markets are sensitive to data from China, its biggest trading partner.

Japan's Nikkei stock average eased 0.2 percent on some disappointing earnings guidance. The Nikkei posted its best April in 20 years, reflecting a sharp improvement in investor sentiment as Japan promotes aggressive policies to end its stubborn deflation and bolster growth.

DOLLAR CONFIDENCE FALTERING

The dollar was vulnerable, staying near lows against a basket of six major currencies which hit its lowest since the end of February at 81.598 on Tuesday.

The dollar edged down 0.1 percent against the yen to 97.36, losing the momentum it needs to challenge the symbolic 100 yen after touching a four-year high of 99.95 yen last month.

The dollar has come under pressure recently after a mixture of weak manufacturing, jobs and growth data for the first three months of 2013 and more positive reports for the housing market.

"The recent weak data has cast doubt over upbeat economic views forecast at the start of the year which had led to speculation about the Fed tapering its aggressive stimulus later this year," said Takao Hattori, senior investment strategist at Mitsubishi UFJ Morgan Stanley Securities.

"Investors are now concerned that data for the current quarter may be weaker than previously thought, and are starting to push back the timing of a shift in the Fed's stance. This is prompting dollar selling."

In this light, the U.S. non-farm payrolls report for April due on Friday is key in gauging the economic trend for the second quarter, Hattori said. March's number came in well below expectations, at 88,000, triggering a sell-off in risk assets.

So far in April, consumer confidence rebounded while the Institute for Supply Management-Chicago business barometer unexpectedly contracted to its lowest level since September 2009. The Standard & Poor's 500 Index settled at an all-time high on Tuesday, despite the mixed bag of economic reports.

While expectations for any change in the Fed's policy were low, the dollar may be whippy after the Fed's statement accompanying its monetary decision, with a bias to the weak side, Sean Callow, a senior currency strategist at Westpac in Sydney, said in a note to clients.

The euro held steady around $1.3163 against the dollar but eased 0.1 percent against the yen at 128.15 yen

"We think meaningful EUR moves will be driven by three fairly unrelated factors, none of which relates to monetary policy in the eurozone," Barclays Capital said in a research note, referring to the effect of a weak yen on Germany's growth, impact from Italy's new coalition government's austerity policies, and a recovery in the U.S. economy.

London copper dropped 0.5 percent to $7,021.25 a tonne as the weak PMI data from top consumer China fueled demand concerns.

"PMIs do tend to come off in April and May, so there is a seasonal aspect, but it's still pretty negative and our Chinese economists are quite bearish right now so that's not great for metals," said analyst Natalie Rampono at ANZ in Melbourne.

U.S. crude futures eased 0.4 percent at $93.05 a barrel and Brent fell 0.8 percent to $101.55.

(Additional reporting by Maggie Lu Yueyang and Michael Sin in Sydney and Melanie Burton in Singapore; Editing by Eric Meijer)