Dollar slides to 2-month low vs euro

TOKYO, Nov 10 (Reuters) The dollar hit a two-month low against the euro and a six-week trough versus the Swiss franc on Friday, sliding for a second day after China's central bank chief said it has a clear plan to diversify its $1 trillion in foreign exchange reserves.

The dollar and other major currencies also took a hit against the yen after Bank of Japan Governor Toshihiko Fukui said he was concerned about a sharp unwinding of carry trades in which investors borrow the low-yielding Japanese currency.

But the dollar pared some of those losses on data showing Japanese machinery orders unexpectedly fell 7.4 percent in September, casting more doubts on a Bank of Japan interest rate increase before year end.

Joseph Kraft, head of FX and interest rates at Morgan Stanley in Tokyo, said Fukui's comments were likely a warning to investors not to get too complacent about holding risky carry trades since the BOJ has said it plans to keep raising rates.

''I think his real intention is to indicate to the market that the BOJ is on a rate hike path,'' he said.

With short-term Japanese rates at just 0.25 percent, a variety of investors have borrowed in yen and used the money to purchase higher-yielding currencies in the carry trade.

Such trades helped to push the euro to an all-time high against the yen on Thursday and the pound to an eight-year peak.

The U.S. currency tumbled across the board on Thursday after comments from China's central bank governor, Zhou Xiaochuan, stirred worries that Beijing may start to shift some of its massive dollar holdings into other currencies and assets.

Analysts said that China's central bank has made similar comments before and the latest remarks were used as an excuse to sell the dollar, which was already undermined on Thursday by a soft University of Michigan consumer sentiment survey.

The euro was up 0.3 percent at $1.2860 after earlier climbing to $1.2868 on electronic trading platform EBS, the highest since the start of September.

The dollar changed hands at 1.2390 Swiss francs after falling to around 1.2375 francs, the lowest since late September.

The dollar slipped 0.3 percent to 117.55 yen but was off the day's low of 117.37 yen.

The euro inched down to 151.15 yen, backing away from the record high of 151.48 yen hit on EBS the previous day.

VIGILANCE ON CARRY TRADES The yen jumped after Fukui said in parliament that there are substantial risks of a sharp unwinding if carry trades are big, and the central bank is watching with vigilance.

The yen has been pummelled on the prospects of only slow rate hikes in Japan, prompting Japanese investors to seek higher returns abroad and a wide array of market players to use the yen for carry trades.

The euro, meanwhile, has benefited from expectations that the European Central Bank will keep bumping up rates from the current 3.25 percent in December and next year.

''Behind the euro's strength is monetary policy and the very good performance of the economy,'' said Kikuko Takeda, currency analyst at Bank of Tokyo-Mitsubishi UFJ.

''Among the G3 currencies and monetary authorities, only the next step for the euro and the ECB is very clear.'' Fukui told the Yomiuri newspaper in an interview on Friday that the BOJ would raise rates pre-emptively but in small steps.

The BOJ is expected to raise rates to 0.5 percent in the first quarter next year.

The market will also tune in to what Fed chief Ben Bernanke has to say on the economy and prospects for overnight rates to stay at 5.25 percent when he takes questions after delivering a speech in Frankfurt.

Several central bankers are attending the conference hosted by the European Central Bank.

REUTERS PKS DS1406