(Adds details, updates prices, changes byline)
* Dollar set for biggest weekly slide since March
* Interest rate outlook continues to favor euro
* Risk-aversion edges up, boosting the yen
By Lucia Mutikani
NEW YORK, May 23 (Reuters) - The dollar fell on Friday and
was on track for its steepest weekly decline against a basket
of major currencies in two months, as investors worried surging
oil prices could deepen an economic downturn and fan inflation
pressures.
Investors shrugged off data showing a sharp fall in euro
zone services activity in May and a slowdown across German's
manufacturing sectors, convinced that boiling oil prices may
even force the European Central Bank to raise interest rates
this year.
Also weighing on the dollar was news that the stock of
unsold U.S. houses touched a record high in April, indicating
that the housing market rout was far from over.
"It just goes back to negative U.S. dollar sentiment that
has been developing in the last while," said Stephen Malyon,
senior currency strategist at Scotia Capital in Toronto.
"The services report didn't appear to hurt the currency.
The market is more concerned about crude oil and the weakness
in the dollar."
The euro climbed to a session high of $1.5794 and last
traded up 0.3 percent at $1.5783 <EUR=>, off a one-month high
of $1.5814 touched on Thursday. On the week, it rose 1.2
percent, the most since March.
The dollar fell 0.8 percent to 103.25 yen <JPY=>. The New
York Board of Trade and Industry's dollar index <.DXY>, which
tracks the dollar's performance against a basket of major
currencies, was down 1.2 percent on the week. If that holds, it
would be its biggest weekly decline since late March. The index
was last down 0.3 percent at 71.943.
Volume on Friday was light, with both the United States and
Britain heading into long holiday weekends. The euro was also
boosted by a report showing Belgian business confidence, a
bellwether for the euro zone, rebounded in May.
"That's contributing to keeping the euro better bid and the
dollar a little bit softer. Of course oil holding around $133
is not helping matters either," said Brian Dolan, chief
currency strategist at Forex.com in Bedminster, New Jersey.
"Right now the dollar is on the ropes and given a lack of
liquidity, the potential is for further dollar losses."
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. economic growth outlook.
But with oil prices surging above $135 a barrel this week,
markets have all but priced out the chances of another Fed rate
cut this year, though a rate increase may be a tough sell at a
time when U.S. growth is slowing.
"For the moment, the focus is on the stagflationary
influences of oil, which is prone to play moderately negative
for the dollar," said Alan Ruskin, chief international
strategist at RBS Greenwich Capital in Greenwich, Connecticut.
He said the euro could push above $1.60 in the third quarter.
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, the
impact on global growth also sparked risk-averse investors to
unwind risky trades funded with cheaply borrowed yen. Nominal
Japanese interest rates stand at just 0.5 percent, the lowest
in the developed world.
U.S. and UK holidays on Monday also encouraged investors to
scale back on risk heading into the long weekend, boosting the
yen and low-yielding Swiss franc.
(Additional reporting by Steven C Johnson; Editing by Leslie
Adler)
