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LONDON, May 24 (Reuters) The euro rose against the dollar on Wednesday after a key gauge of German business confidence gave a stronger than expected reading, but emerging market jitters helped the dollar against the yen.

The German Ifo business climate index for May came in at 105.6, below April's 15-year high of 105.9 but above the consensus forecast of 105. The forward-looking indicator for the euro zone's largest economy is closely-watched by markets, which are looking for a euro zone rate hike in June.

The dollar steadied against the yen after rising as a report of possible human-to-human transmission of bird flu in Indonesia added to a broad unwinding of emerging markets positions.

''We are expecting the ECB to go for 50 basis points in June,'' said Ian Gunner, head of foreign exchange research at Mellon.

''The fundamental arguments still work against the dollar, but if we get an unwinding of all the portfolio flows of the last year, you will see a short-term move back into U.S. assets and the dollar.'' By 1145 GMT, the euro was up a quarter percent at $1.2855, but off a session high of $1.2879.

The dollar was trading at 111.95 yen after rising as high as 112.64 yen.

The euro also rose a third of a percent against the yen, to 143.89.

CENTRAL BANKERS The strong Ifo reading reinforced expectations for more euro-supportive interest rate rises in the euro zone this year from the current 2.5 percent.

May inflation data for the German states of Baden- Wuerttemberg, North Rhine-Westphalia and Brandenburg came in at year-on-year rates of 1.9 percent, 1.7 percent and 2.3 percent respectively.

The euro also rallied on talk of central bank buying of euros, with some traders citing the People's Bank of China.

''China obviously is heavily buying into euro,'' said a Frankfurt-based trader.

Reserve diversification has been a major theme for currency markets, helping the euro to record highs against the dollar in late 2004.

U.S. global imbalances are also a major theme, with Asian central banks providing much of the inflows into U.S. assets.

Investing Asian currency reserves in Wall Street and U.S.

Treasuries was not the most efficient use of them, and they should be used in the region, South Korean Finance Minister Han Duck-Soo said in an interview with Reuters on Wednesday. He said that any change to Asian currency reserves' investments would be ''very, very gradual''.

Traders were awaiting data on U.S. durable goods orders and new home sales in April, due at 1230 GMT and 1400 GMT for clues about the prospects for rates in the United States, which many think are near their peak at the current 5 percent after two years of tightening.

''We have taken two years to get to this point, and now the market is very nervous about what the Fed is going to do,'' said Paul Robson, currency strategist at RBS Financial Markets.

Economists expect a median drop in orders of 0.5 percent compared with a rise of 6.4 percent the previous month. New homes sales are also expected to fall.

BIRD FLU FLUTTERS The World Health Organisation (WHO) said on Tuesday that an Indonesian who died of bird flu after nursing his sick son may have caught the virus in a case of direct human-to-human transmission.

The WHO, which believes some limited human-to-human transmission has occurred before in other countries, stressed that the virus was not yet spreading easily among people -- which could be a first step toward a pandemic.

The Indonesian rupiah fell more than one percent and other Asian currencies weakened on the news. The Turkish lira tumbled to a two-year low versus the dollar.

On Tuesday, Mexico's stock market fell nearly 1.5 percent and Brazil's bourse slid more than 1 percent, as investors' recent aversion to risk continued.

''Every institution is getting squeezed, whether you are a bank or fund, in emerging markets. People are taking risk off the table,'' said a foreign exchange trader at a UK bank.

European stock markets also felt the heat on Wednesday, dropping around 2 percent in nervous markets, and U.S. stock index futures were pointing to a lower open on Wall Street.

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