Array

TOKYO, Aug 7 (Reuters) The dollar steadied against the yen on Tuesday after rallying in the previous session on a strong recovery in the U.S. stock market, which helped ease investor worries about a credit squeeze.

The dollar's gains will likely be limited ahead of the Federal Reserve's one-day policy meeting later in the session, as traders wait to see if the central bank comments on risks to economic growth from woes in the U.S. credit market.

''Players continue to focus on the stock markets, and it's unlikely that investors will resume carry trades just yet, especially when we don't know what would come out of the Fed's statement,'' said a senior trader at a big Japanese bank.

Traders have been taking cues from stock markets as a measure for risk appetite and a sell-off in stock markets had prompted investors to unwind risky carry trades, where they borrow in a low-yielding currency such as the yen to invest in higher-yielding assets.

The Fed is expected ot keep interest rates on hold at 5.25 percent. Many traders expect the Fed to reiterate its previous view, emphasizing inflationary pressures as the predominant risk to its scenario for the economy.

Traders said that addressing the current credit market crisis would unnecessarily unsettle the market which has already been battered.

''Still, we can't rule out the possibility the Fed may hint at an interest rate cut,'' the Japanese bank trader said.

If the Fed sticks to its previous view, the dollar could gain, but traders said the U.S. currency's direction will be dictated by the stock market reaction to the Fed's post-meeting statement.

The dollar was down 0.1 percent at 118.72 yen The dollar tumbled to a four-month low against the yen while the New Zealand dollar fell sharply versus the Japanese currency on Monday as worries about a credit crunch prompted an unwinding of risky carry trades.

The high-yielding New Zealand dollar was down 0.25 percent at 90.70 yen The euro was up 0.1 percent at $1.3812 U.S. stocks rallied on Monday on bargain-hunting, with the Dow Jones industrial average jumping 2.18 percent to end at 13,468.78.

The dollar index, a measure of the greenback's value against a basket of six of its most heavily traded counterparts, was at 80.231, off a 15-year low hit on Monday when the index fell below 80.000.

REUTERS PBB VP0720