Dollar flexes muscles on upbeat data; kiwi knocked lower

SYDNEY (Reuters) - The U.S. dollar hovered at seven-month highs against a basket of currencies on Thursday as investors warmed to the greenback following bullish economic data, while dovish comments from New Zealand's central bank sent the kiwi dollar packing.

The dollar index <.DXY> stood at 82.899, having climbed as far as 83.055 after U.S. retail sales rose at their fastest clip in five months in February. The report is the latest in a string of data putting the world's biggest economy well on the recovery path.

Against the yen, the greenback edged up to 96.09, bringing it within a hair's breadth of a 3-1/2 year peak of 96.71 set on Tuesday.

While the improving economic picture is unlikely to compel the Federal Reserve to reduce its monetary policy support, it has helped boost demand for the greenback, particularly against the euro and yen, both of which are facing bigger economic problems of their own at home.

For the yen, expectations of aggressive policy easing from the Bank of Japan and talk of an inter-meeting move are keeping investors well away, while economic weakness in the euro zone and political uncertainty in Italy are weighing on the euro.

The common currency skidded to a three-month low of $1.2923, before finding a tentative footing to last trade at $1.2958. It has shed nearly 6 percent from a peak of $1.3711 set early last month. Support is seen around $1.2906, a level representing the 76.4 percent retracement of its Nov-Feb rally.

The euro also slipped against the yen, dipping to 124.55 and putting more distance from a 34-month peak of 127.71 set last month.

Further weighing on the euro was a lukewarm bond auction in Italy that saw investors demand higher yields for its three-year paper, following a recent credit ratings downgrade triggered by the country's political paralysis.

Investors also took aim at the kiwi dollar after the Reserve Bank of New Zealand pledged to keep its cash rate steady at a record low 2.5 percent this year and even flagged a possible cut should certain conditions be met.

The RBNZ also warned that worsening drought conditions throughout the country could have a marked negative impact on growth.

The kiwi traded at $0.8189, having slid to a 2-1/2 month low of $0.8162. It also fell against its Australian counterpart, which climbed to two-month highs of NZ$1.2605.

"The RBNZ has come across outwardly sounding more dovish than last time, explicitly raising 2‑way risks around its outlook," said Chris Tennent-Brown, FX economist at Commonwealth Bank.

"A key factor on the dovish side was a bigger emphasis on the potential for OCR cuts in response to the NZD remaining at recent levels for 9 months longer than the RBNZ has factored in."

The Australian dollar softened in sympathy with its Antipodean peer, easing below $1.0300 from a high of $1.0336. It's immediate fortunes will be determined by the outcome of a closely watched employment report due at 0030 GMT.

Forecasts centred on a modest rise of 9,000 jobs and the unemployment rate to creep up to 5.5 percent. Given that markets have nearly priced out the risk of an interest rate cut this year, any downside surprise could see investors quickly factor one back in, knocking the Aussie lower.

Elsewhere in Asia, the Bank of Korea will announce its policy decision around 0100 GMT. Analysts polled by Reuters expect South Korea's central bank to keep interest rates steady for a fifth straight month.

In Europe, the Swiss National Bank is also expected to hold fire at its policy meeting, but will keep defending the lid it set on the franc at least through 2013 and probably well into 2014, a Reuters poll found.

The euro was little changed around 1.2345 Swiss francs, well off the SNB's ceiling of 1.20.

(Editing by Wayne Cole)