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Dollar slides to 8.5 month lows on US economy worries

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The dollar fell to eight-and-a-half-month lows against the euro and a currency basket on Friday on expectations the U.S. Federal Reserve may delay scaling back its monetary stimulus following this month's political battles over the budget.

Analysts said concerns about the negative impact on the U.S. economy and the likelihood the Fed would leave its bond-buying program intact until well into next year would weigh on the dollar, leaving the euro the potential to rise towards $1.40.

The dollar index, which measures the dollar's value against a basket of currencies, was last flat at 79.67, its lowest since early February.

The euro rose to $1.3673 against the dollar, its highest since early February and near its 2013 peak of $1.3711.

(Read more: Fitch's ominous US warning; earnings show shutdown strain)

A little over a month ago, analysts were convinced the Fed was ready to embark on the first step of reining in five years of ultra-loose monetary policy for the world's biggest economy.

But the Fed unexpectedly left policy unchanged in September. This was followed by a 16-day halt in U.S. government spending in October, then a deal over the debt ceiling which leaves scope for further wrangling over the budget early next year.

"Expectations for tapering have been pushed out and that will be negative for the dollar ... The trend is definitely pointing towards $1.40 for the euro,'' said Niels Christensen, currency strategist at Nordea in Copenhagen.

Analysts at Citi also said the euro could move closer to $1.40 in the near term due to the expected delay in the Fed reducing stimulus. They expect the euro to be bought "as a safe haven and reserve proxy for the dollar."

The dollar index was down around 1 percent on the week and on track for its biggest weekly decline since mid-September after the surprise Fed decision.

"The market will come round to the idea that tapering is off the agenda until the back end of Q1 or even Q2, and that is a powerful dollar negative," said Paul Robson, currency strategist at RBS.

The deal reached on Wednesday only funds the U.S. government until Jan. 15 and raises the borrowing limit through to Feb. 7.

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The first wave of U.S. data released on Thursday after the government returned to work was fairly upbeat. But the main focus is on the September payrolls report, which the Labor department said will be published on Tuesday.

The dollar also struggled against the yen after a fall in U.S. bond yields undermined the U.S. currency's allure.

It was last down 0.1 percent on the day at 97.80 yen, below a three-week high of 99.01 yen reached on Thursday.

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