Dollar retreats in holiday thinned-trading

By Gertrude Chavez-Dreyfuss

NEW YORK, Dec 27 (Reuters) - The dollar weakened on Wednesday in light post-Christmas trading as a weak housing industry data added to the perception of a U.S. economic slowdown.

Investors focused on the diverging interest rates outlook between the euro zone and United States, where fresh economic reports of a sluggish economy tend to reinforce expectations of of interest rate cuts next year in the world's largest economy.

The euro rose 0.4 percent against the dollar to $1.3147 . The dollar was flat against the Swiss franc at 1.2224 francs . Sterling, meanwhile, was up 0.3 percent at $1.9591 .

Reports that the United Arab Emirates' has decided to increase the proportion of its euro reserves over the next few months may have also weighed on the dollar, analysts said.

"All in all, it's not looking to be a positive backrop for the dollar," said Shaun Osborne, chief currency strategist at TD Securities in Toronto.

Osborne cited Tuesday's weak numbers for both Richmond and Dallas Federal Reserve manufacturing surveys including a report on Wednesday showing a sharp fall in U.S. mortgage applications.

The Mortgage Bankers Association said U.S. mortgage applications plummeted last week to the lowest level in nearly five months, dragged down by a plunge in demand for home refinancing loans. For more click on [ID:nNAT002350].

Data on November's new home sales due at 10 a.m. (1500 GMT) is seen as a key in determining if and when the Fed would begin cutting interest rates.

"So we've got the two bugbears of the dollar -- housing and manufacturing -- which are not flashing very positive signals at the moment," said Osborne.

The euro, on the other hand, continued to rack up gains, with the European Central Bank expected to raise interest rates further next year from the current 3.5 percent.

The single currency earlier hit a 6-1/2 year high versus the Swiss franc at 1.6083 , buoyed by expectations that euro zone interest rates are set to rise further in 2007. By contrast, the Swiss National Bank slashed its 2007 interest rate outlook after raising rates earlier this month.

Against the yen, the dollar fell 0.6 percent to 118.41 yen , after Jiji news agency reported late on Tuesday that the Bank of Japan is likely to discuss raising rates to 0.5 percent next month.

Jiji, citing no sources, added that the decision could be postponed to February or later in the event of anything unexpected happening in financial markets.

"There was a bit of a turn in the yen that may have been the catalyst for more dollar weakness," said Daragh Maher, currency strategist at Calyon.

However, a trader at Forex.com in Bedminster, New Jersey doubted this report. "We believe this to be highly unlikely as far as event risk, but, the revaluation of the Chinese yuan is a real event," he said.