NEW YORK (Reuters) - The U.S. dollar fell to a two-month low against major currencies on Wednesday after weaker-than-expected U.S. economic reports reinforced expectations the Federal Reserve will maintain its stimulative monetary policy.
The Fed ends its two-day policy meeting later in the day and is widely expected to keep its monthly purchases of $85 billion in bonds to support an economic recovery that's showing signs of losing momentum.
Sentiment on the dollar began to change after recent data showed below-forecast U.S. first-quarter growth and an unexpected contraction in business activity in the Midwest, reviving fears the U.S. economy has hit a soft patch.
"In last month's (Fed) meeting everyone was keen on finding out just how much the Fed board was discussing the potential for shutting down quantitative easing," said Paul Bregg, a currency trader at Western Union Business Solutions in Denver, Colorado.
"That was when U.S. data was constantly surprising the market, things have changed and the U.S. dollar picture is not quite as bright as first thought."
The dollar index .DXY, which measures the U.S. currency's value against a basket of currencies, dropped as low as 81.331, its weakest since February 25. It was last at 81.608, down 0.2 percent.
Data released on Wednesday added to those worries. U.S. companies hired the smallest number of employees in seven months in April while manufacturing growth slowed. Another report showed U.S. construction spending dropped to a seven-month low in March.
Investors are waiting to see if a sluggish recovery and slowing inflation may even push the Fed into buying more assets. Only a month or so ago, investors expected the Fed to start scaling back asset purchases.
"We think the Fed will be as dovish as it can afford to be, and as such the softness of the dollar is justified and if anything it could extend a bit further," said Adam Cole, global head of FX strategy at RBC Capital Markets.
Investors will get further clues about the health of the economy when the government releases its nonfarm payrolls report for April on Friday. Economists are looking for job growth of 145,000 last month, up from 88,000 for March.
ECB RATE CUT
Weakness in the dollar helped drive the euro to a two-month high despite growing expectations the European Central Bank will cut interest rates on Thursday.
With the May Day holiday keeping most of Europe's markets closed, the euro rose 0.2 percent to $1.3193. It had earlier risen to $1.3242, according to Reuters data, its highest level since February 25.
But the euro's gains may be limited, given Europe's deteriorating economic outlook. Many traders expect the euro to fall if the ECB cuts rates on Thursday.
"With the (Fed) surely expected to downgrade its economic view today, the ECB has little choice but to cut rates in order to avoid another excessive euro rally," said Ashraf Laidi, chief global strategist at City Index Ltd in London.
"A 25-basis point cut may be insignificant, but failure to cut would disappoint 80 percent of market participants expecting a rate cut, which may trigger a fresh euro rally to the detriment of the already struggling euro zone, including a recession-bound Germany."
Some analysts said the euro could eventually strengthen should the ECB take steps to shore up growth.
Against the yen, the dollar slipped 0.2 percent to 97.25 yen.
The pound rose to its highest against the dollar since mid-February at $1.5597, helped by a better-than-expected UK manufacturing survey.
The Australian dollar fell 0.8 percent to $1.0282 after data showed growth in China's manufacturing sector unexpectedly slowed.
(Additional reporting by Nick Olivari; editing By Andrew Hay)