FOREX -Euro hit six-week high on euro zone banking deal prospects
* EU moves closer to creating euro zone banking union
* Euro rises for 6th straight day to six week high
* Cable at two-year high on upbeat central bank comments, strong housing
NEW YORK, Dec 10 (Reuters) - The euro hit a six-week peak against the dollar on Tuesday, helped by expectations of a banking deal in the euro zone and a growing view the Federal Reserve needs more positive economic data before it decides to start reducing its monetary stimulus.
Europe's common currency rose for a sixth straight day versus the greenback to within striking distance of the 2013 high of $1.3832, reached on Oct. 25.
The euro's strength pushed the dollar index down for a second straight day to a six-week low, last trading down 0.22 percent to 79.95.
Investors have sold the dollar steadily for the last month on diminishing prospects the Fed would start reducing its asset purchases in December. The quantitative easing program floods the markets with greenbacks, keeps interest rates low and yields less appealing to investors.
But the market's focus has been on the euro and its resilience.
European Union finance ministers, meeting in Brussels, edged closer to agreeing on a plan to form a new agency charged with closing down ailing euro zone banks and sharing the costs. The issue is crucial as a banking union is widely viewed as shoring up the euro zone against future debt and financial crises.
"There's some expectation that a deal may be reached before year-end, and that is supportive of the euro," said Sireen Harajli, currency strategist at Mizuho Bank Ltd in New York.
On the monetary policy side, a combination of the European Central Bank's less-dovish tone and the failure to focus on negative interest rates at the last meeting has also underpinned the euro.
The euro reached the six-week high of $1.3795 before slipping to $1.3759, a gain of 0.15 percent on the day.
"We're going to see a breakout in the euro soon and we could see it test $1.39," said Andres Bergero, chief corporate trader at Bank of the West in San Ramon, California.
"The euro zone economy is still fairly fragile, but there aren't as many fires as before. So there is a perceived notion that things are a little bit better, a little more stable in Europe."
The euro, however, has become overvalued, according to BNP Paribas' short-term estimates, and should decline over the next few weeks. Current fair value for the euro is at $1.3590, BNP said, up from $1.3535 previously.
Against the yen, the euro hit a five-year peak of 142.17 yen , a high not seen since October 2008, but it was last down 0.3 percent at 141.46.
The euro has gained over 1.5 percent against the dollar and 2.7 percent versus the yen since the ECB last week refrained from following up on November's rate cut and said it has yet to come up with a detailed plan on which tools to use and when.
Sterling hit a two-year high against the dollar as investors took upbeat comments from the Bank of England and strong house prices as signs that interest rates could rise sooner than previously thought.
The pound rose to $1.6468 in Asian trading, its best since August 2011 before dipping back to $1.6443, up 0.9 percent on the day.
Traders said investors seemed to have pretty much priced out the risk of the Federal Reserve scaling back monetary policy soon, which might help explain why the dollar has not risen broadly in the past few sessions.
"We had pretty good data for the U.S. last week and that has prompted some to expect tapering in December, but I think that's not realistic," said Mizuho's Harajli. "I think we need to get more information, more data before the Fed can actually decide on that."
Economists polled by Reuters on Monday expect the Fed will begin reducing, or tapering, its massive bond-buying program in March.
Against the yen, the greenback fell 0.46 percent to 102.79 yen.
One possible concern for yen bears is that support for Japanese Prime Minister Shinzo Abe dropped after he steam-rolled through parliament a tough secrecy act that critics fear could muzzle media and allow officials to hide misdeeds.