Dollar flexes muscles on upbeat US retail sales, Aussie jumps

SYDNEY/TOKYO (Reuters) - The U.S. dollar hovered near seven-month highs against a basket of currencies on Thursday after bullish U.S. retail sales data fanned hopes the economy can cope with the tax hikes and spending cuts that kicked in this year.

The Australian dollar shot up to five-week highs after a startlingly strong local employment report forced traders to see no chance of near-term rate cuts in Australia.

The dollar index <.DXY> stood at 82.845, almost flat on the day, having climbed as far as 83.055 on Wednesday 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.

While the improving economic picture is unlikely to compel the Federal Reserve to reduce its monetary policy support any time soon, it highlighted the resilience of the U.S. economy to tax hikes in January and spending cuts starting from March.

In contrast, 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 on Wednesday and last stood at $1.2962, little changed from late U.S. trade, with bids from an Asian central bank giving it a temporary support.

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 124.22 and putting more distance from a 34-month peak of 127.71 set last month.

The yen found a reprieve also against the dollar, which fell 0.3 percent to 95.83 yen as Japanese companies repatriated funds ahead of their financial year-end on March 31.

"(Dollar/yen) buyers seem cautious now, after they have seen how dramatically the dollar can fall after the Italian election," Takahiro Suzuki, vice president of forex at Nomura Securities.

On February 25, when it became evident that no political forces won an outright majority in the Italian election, the dollar fell more than 4 percent against the yen from that day's high.

Still, expectations of aggressive policy easing from the Bank of Japan are expected to underpin the dollar/yen, with many traders looking to buy the greenback near 95 yen, for a retest of 3 1/2-year high of 96.71 yen hit on Tuesday.

The British pound, which had been pummeled by expectations of more quantitative easing from the Bank of England, gained 0.2 percent to $1.4947, extending its rebound from a 33-month low of $1.4832 hit on Tuesday.

The biggest gainer of the day, however, was the Australian dollar, which jumped after a surprisingly strong Australian job data quashed expectation of further rate cuts by the Reserve Bank of Australia.

The Aussie gained 0.7 percent to $1.0370, rising as high as $1.0383 at one point, its highest in more than five weeks.

In contrast, investors 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 slid to a 2-1/2 month low of $0.8162 and last stood at $0.8181, down 0.1 percent on the day.

"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."

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 franc was little changed around 1.2340 Swiss francs per euro, well off the SNB's ceiling of 1.20.

(Editing by Richard Borsuk)