* U.S. dollar index has strongest week since October 2008
* Softness lingers in U.S. retail sales, CPI data
* Euro drops as peripheral bond spreads widen
(Adds quotes, updates prices, adds detail, change byline)
By Steven C. Johnson
NEW YORK, Aug 13 (Reuters) - The dollar on Friday headed
for its best week against major currencies in nearly two years
as a lackluster Italian debt sale and tepid U.S. consumer data
fed fear that slower U.S. growth would hurt the world economy.
The euro fell to a three-week low against the U.S. currency
as spreads between peripheral European and benchmark German
government bonds widened. Analysts said weak demand for Italian
five- and 15-year bonds renewed fear about euro zone deficits.
U.S. data showing a smaller-than-expected rebound in July
retail sales and consumer inflation at its lowest level since
the 1960s added to recent evidence that the U.S. economy has
slowed considerably.[]
The fear, analysts say, is that if the U.S. economy slows
enough, demand for Chinese goods and for the bonds of indebted
euro zone countries such as Greece and Spain could dwindle.
That boosted a safe-haven bid for the greenback.
"I think we're heading into a very volatile period, and I
certainly wouldn't rule out a couple more weeks of the dollar
doing well," said Jens Nordvig, head of G10 currency strategy
at Nomura Securities in New York.
This week was shaping up to be the dollar's best since
October 2008, with an index of the greenback against six major
currencies <.DXY> up 3.1 percent since Monday.
The euro, the biggest component of the index, hit a
three-week low of $1.2753 before clawing its way back to
$1.2770 <EUR=>, down 0.4 percent.
A close below $1.2777, the 38.2 percent Fibonacci
retracement from the pair's low set on June 7 to its high on
Aug. 6, is seen as a bearish sign. Traders said the next
support level is around $1.2610, the 50 percent retracement.
The yen was the major currency to do well against the
dollar this week, as falling U.S. bond yields prompted Japanese
investors to take profits on Treasury holdings and repatriate
funds. While the dollar rose 0.4 percent Friday to 86.24 yen
<JPY=>, it was near a 15-year low earlier this week.
DOLLAR ENTERING NEW PHASE
The dollar had been under heavy selling pressure since
early July as investors focused on deteriorating economic
conditions in the United States. But the currency rebounded
sharply this week on the view that if the U.S. economy is
slowing, it is not alone.
Nordvig said that has sparked an unwinding in speculative
short dollar positions and carry trades in which investors
borrow dollars cheaply to buy higher-yielding assets.
One target of such trades has been peripheral euro zone
bonds. Worries about a euro zone debt crisis drove up Spanish
and Portuguese yields earlier this year.
"People have tried to pick up some 'carry' in these bonds,
because some were offering 200 to 300 basis points of yield,
making them better than some other carry trades," he said.
Doubts about global growth and increased currency
volatility has made such positions less comfortable, he said.
Indeed, after weeks of focusing on U.S. sluggishness,
anxiety flared this week about Europe. The spread between
10-year Greek and German bonds widened to its most since the
European Central Bank began a bond-buying operation on May 10,
while he spread between Spanish and German 10-year government
bonds also widened. [] [].
Analysts said anxiety was high enough to prevent the euro
from getting a lasting bounce from data showing Germany's
economy grew more than expected. [].
Nordvig said recent U.S. data, while weaker, still points
to growth rather than a "double-dip" recession.
"If future U.S. data comes in less bad than the consensus,
that could help the dollar against the yen but support the euro
and currencies like the Australian dollar, which is the most
sensitive major currency to growth," he said.
(Reporting by Steven C. Johnson and Wanfeng Zhou; Editing by
Kenneth Barry)
