* Euro <EUR=> hits 2-month high of $1.3723 versus dollar
* Diverging euro zone, U.S. rate views boost common currency
* Technical resistance in focus around $1.3740
* But wariness before Fed; policy seen staying accommodative
(Adds quote, updates prices)
By Neal Armstrong
LONDON, Jan 26 (Reuters) - The euro hit a two-month high
versus the dollar on Wednesday on perceptions that interest
rates will rise sooner in the euro zone than in the U.S., taking
out option barriers on the way and approaching key resistance.
The dollar hit a 10-week low against a basket of currencies
with the market looking for confirmation from the Federal
Reserve later in the day that its focus remains on supporting
growth.
The belief that the Fed will stick to a much easier policy
than the European Central Bank, which is growing worried about
inflation, has helped the euro to extend its recovery after a
two-month drubbing on worries over euro-zone debt.
But the euro's rally was still on shaky ground, while
analysts said market players may be wary of selling the dollar
too much ahead of the Fed announcement, with policymakers likely
to acknowledge a recent improvement in the U.S. economy.
"It will be interesting to see the reaction of the Fed to a
general improvement in economic data, which could prove a
rationale to stem dollar-selling," said Jeremy Stretch, currency
strategist at CIBC.
"People may prove reluctant to be too short of dollars
before the Fed statement in case of a general hardening of the
tone".
The euro <EUR=> rose to $1.3723 on trading platform EBS, its
highest since November 22, before dipping back to $1.3693.
Traders said a large option barrier was taken out at
$1.3720, with more barriers highlighted at $1.3725 and $1.3750.
Stop-losses were reportedly lurking above the latter level.
The euro stalled ahead of a key technical level around
$1.3740, the 61.8 percent retracement of its fall from November
to January. Beyond that, its Nov. 22 high of $1.3786 is seen as
a major target.
"Most of this euro rally seems to be driven by speculators
with no major structural inflows coming into the euro zone,"
said Manuel Oliveri, currency strategist at UBS in Zurich.
FED FOCUS
The dollar index was down 0.2 percent at 77.809 <.DXY>,
having hit a 10-week low of 77.748.
Analysts expect the U.S. central bank will keep short-term
rates near zero and will say it remains committed to its $600
billion bond purchase programme in its policy announcement later
today. []
"The Fed seems to have welded monetary policy to the U.S.
unemployment rate which is still very high. Until there is some
moderation down to around 8 percent in the jobless rate it's
hard to think there could be any change in policy," said
Kathleen Brookes, Research Director at FOREX.com.
The dollar was under pressure after U.S. bond yields fell on
news of President Barack Obama's proposal to freeze portions of
federal spending in his State of the Union address on Tuesday.
The FOMC's policy outlook contrasts with that of the ECB.
Governor Jean-Claude Trichet has warned about rising inflation
in the region, sparking talk of a rate hike later this year and
helping to widen the euro's rate advantage over the dollar.
The euro also continued to benefit from strong demand for
inaugural bonds from Europe's financial rescue fund on Tuesday.
Asian investors, including the Japanese government, took up more
than one-third of the 5 billion euro offer. []
The dollar was flat at 82.16 yen <JPY=>, not far from last
week's two-week low of 81.85.
(Additional reporting by Jessica Mortimer; editing by
Stephen Nisbet)
