NEW YORK (Reuters) - The dollar fell from a recent seven-month high against a basket of currencies on Friday as investors opted to book profits after U.S. inflation data kept the door open for the Federal Reserve to continue its bond-buying program for the foreseeable future.
The greenback notched its first weekly loss against the euro in six weeks, but after hitting a three-month high the previous session investors turned cautious and pared bullish dollar bets ahead of next week's Fed policy meeting.
Currency speculators boosted their bets in favour of the U.S. dollar in the latest week to the highest in eight months, according to data from the Commodity Futures Trading Commission released on Friday.
"But a steady stream of mostly encouraging U.S. data should keep intact the dollar's underlying uptrend," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington, D.C.
"The euro's underlying trend remains bearish on the view America's recovery was far outpacing the recession-beset euro zone," he said.
U.S. manufacturing output bounced back in February, the latest signal of strength in an economy that is showing clear momentum despite the headwind of government austerity.
While other reports showed a surge in gasoline prices caused a spike in consumer inflation last month and eroded consumer sentiment in early March, the impact on the economy was likely to be limited and temporary.
Gasoline accounted for about three quarters of the spike in consumer inflation in February, leaving the door open for the Fed to press ahead with its bond-buying stimulus, which is bearish for the dollar.
The Fed's program is tantamount to printing money and therefore dilutes the dollar's value.
"It looks like we still have some scope to continue with QE," said Andrew Dilz, foreign currency trader at Tempus Consulting in Washington, referring to the Fed's bond-buying, or quantitative easing program.
The dollar index, which tracks the greenback versus a basket of currencies, fell 0.5 percent to 82.219. It had risen to 83.166 on Thursday, the highest since early August, buoyed by positive data on U.S. employment and consumer spending released over the past week.
The Fed meets next week and looks set to keep buying $85 billion a month in mortgage and Treasury bonds in an effort to encourage investment and bolster a weak economic recovery. The program is aimed at keeping long-term interest rates low, eroding the dollar's yield appeal.
Lately, the dollar has benefited from good news on the economy as expectations U.S. growth is outperforming other major countries have lured foreigners into U.S. assets.
"We continue to believe that the relative performance of the U.S. economy will bolster the dollar over the medium term, especially versus currencies with central banks that are expected to adopt a more stimulatory stance, such as the yen and British pound," Barclays Capital wrote on Friday.
Nevertheless, sterling jumped after Bank of England chief Mervyn King said its decline had gone far enough, although traders did not expect the pound's rise to last long given concerns about the UK economy and speculation of more monetary easing.
The euro gained on the prospect of EU leaders looking at short-term ways of boosting faltering euro zone economies.
The euro rose 0.4 percent to $1.3054, having hit a session high of $1.3107 on Reuters data and recovering from Thursday's three-month low of $1.2910.
Arne Lohmann Rasmussen, head of FX research at Danske Bank in Copenhagen, said the euro could recover further towards $1.32 in coming weeks. Danske Bank forecast it to rise to $1.35 in three to six months but believes this will mark its peak.
Concerns about Italy could pressure the euro as the country's parliament convenes for the first time since last month's inconclusive election.
Meanwhile, Japan's parliament approved Prime Minister Shinzo Abe's nominee for central bank governor, Haruhiko Kuroda, and nominees for the two deputy governor posts, clearing the way for radical monetary easing.
Kuroda's pledge to "act with speed" and do whatever it takes to hit the BOJ's new inflation target has some investors speculating he may summon a meeting even before the next scheduled policy review on April 3-4.
The dollar last traded at 95.38 yen, down 0.7 percent on the day, with the Japanese currency helped by short-covering after a decline of about 10 percent this year. The dollar earlier fell to 95.06 yen, a one-week low, according to Reuters data.
Additional reporting by Gertrude Chavez-Dreyfuss and Wanfeng Zhou; Editing by James Dalgleish