(Adds comment, updates prices, changes dateline)
* Dollar set for biggest weekly slide since March
* Interest rate outlook continues to favor euro
* Market awaits U.S. existing home sales data
NEW YORK, May 23 (Reuters) - The dollar fell on Friday and
was set for its steepest weekly slide against a basket of major
currencies in two months, as record high oil prices left the
U.S. economy vulnerable to slower growth and rising inflation.
The euro, by contrast, remained on a solid footing despite
data showing tepid growth in the euro zone's services and
manufacturing sectors. Analysts said that despite the slowdown,
the economy was still robust enough to allow the European
Central Bank to focus on restraining price pressures.
"We had a massive shift generally in the past couple of
weeks and the market now sees the ECB hiking rates," said
Marcus Hettinger, FX strategist at Credit Suisse in Zurich.
"Consumers in the U.S. are already under stress from
housing, and now...we have rising oil prices. Basically it
means interest rates will remain low in the U.S. despite rising
inflation...and that's one of the reason why the dollar will
remain weak," Hettinger said.
Against a basket of six major currencies <.DXY>, the dollar
was down nearly 1 percent on the week. If that holds, it would
be its biggest weekly decline since late March.
The euro was up 0.2 percent at $1.5755 <EUR=>, off a
one-month high of $1.5814 touched on Thursday, while the dollar
fell 0.7 percent to 103.30 yen <JPY=>.
Volume was light, with both the U.S. and Britain heading
into long holiday weekends, though analysts said U.S. existing
home sales data due at 10 a.m. could provoke a last flurry of
activity before trading desks thin out.
Earlier this week, the Federal Reserve said the slumping
U.S. housing market likely had further to fall and also
downgraded its 2008 U.S. growth outlook.
But with oil prices surging above $135 this week, markets
have all but priced out the chances of another Fed rate cut
this year, though a rate increase may be also a tough sell at a
time when U.S. growth is slowing.
This toxic combination of weak growth and high prices has
kept the dollar under steady pressure this week.
Meanwhile, a flurry of strong data on inflation and
business sentiment from the euro zone has left markets thinking
the European Central Bank's next move may be an interest rate
hike, and that's tilted sentiment in favor of the euro.
Lower-than-expected euro zone manufacturing and services
data "confirm that the underlying growth trend in the euro zone
economy is firmly down and that growth in the second quarter
indeed will be less flattering," ING said in a note.
"However, the activity data are not yet weak enough to
dilute the ECB's concerns about the medium-term inflation
outlook, which is the primary factor driving its monetary
policy decisions."
The low-yielding yen was a strong performer heading into
the long weekend, with the euro down 0.5 percent at 162.82 yen
<EURJPY=>.
Although Japan is vulnerable to higher oil costs, their
impact on global growth also sparked risk-averse investors to
unwind risky trades funded with cheaply borrowed yen.
Also, strategists at Scotia Capital said the yen was
enjoying "some interest rate support" after Bank of Japan
meeting minutes showed officials stressing the need to monitor
consumer inflation expectations more closely.
Nominal Japanese interest rates stand at just 0.5 percent,
the lowest in the developed world.
(Additional reporting by Toni Vorobyova in London; Editing
by Chizu Nomiyama)
