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FOREX-Euro falls after soft inflation data, yen firm

Laurence Fletcher
Friday, 31 Jan 2014 | 8:16 AM ET

* Euro zone inflation posts surprise fall

* Risk aversion, Japanese inflation helps yen,

* Dollar supported by month-end flows

* Canadian dollar comes close to new 4-1/2 year low

LONDON, Jan 31 (Reuters) - The euro fell on Friday as soft euro zone inflation data reawakened concerns the European Central Bank may have to act to avert deflation, while the yen gained as investors looked for safe havens amid the emerging market sell-off.

The euro was 0.1 percent lower against the dollar at $1.3538 , while against the yen it hit a two-month trough of 138.395 yen.

Risk aversion also hit commodity-related currencies, with the Canadian dollar falling to C$1.1198 per dollar, within a whisker of a new four-and-a-half-year low.

Prices were affected as international investors changed the hedges on their positions at the end of the month, while volumes were light with large parts of Asia on holiday for the Lunar New Year.

Euro zone inflation data on Friday showed a surprise drop to 0.7 percent year-on-year in January, while analysts had expected a rise to 0.9 percent.

The fall could be a trigger for further easing by the European Central Bank, which holds its policy review next week, to sustain a fragile recovery and ward off deflation.

"I'm not sure if that's enough for them (the ECB) to make a change in policy, but it's certainly worrisome," said Marshall Gittler, head of global FX strategy at IronFX Global.

The spread between U.S. two-year government bonds yields and German two-year yields also widened, putting pressure on euro-dollar.

One London-based trader reported buyers for the euro on the dips against the dollar, with range trading looking most likely for the single currency.

IronFX's Gittler also pointed to the sell-off in emerging markets as a headwind for the European economy.

That sell-off, however, has benefited the yen - last year's weakest major currency - as the dollar fell 0.4 percent to 102.28 yen on Friday, with large option expiries at the 102.25 and 103 levels, according to one trader.

The yen also rose as the Nikkei fell. The two tend to move in opposite directions, with a rally in the index often a signal for speculators to sell the yen and buy higher-yielding currencies, while that trade may be unwound when risk appetite falls.

"The market is taking its cues from emerging markets to quite a large degree," said Adam Cole, head of G10 FX strategy at RBC Capital.

Another boost was Japan's core consumer price inflation, which accelerated to 1.3 percent in January, the highest level in five years.

But the Australian dollar, widely seen as a proxy for riskier assets, was 0.9 percent lower at $0.8713.

The dollar index edged up 0.1 percent to 81.144, helped by solid U.S. October-December growth numbers, which revived hopes that the global economy could, on the whole, take troubles from emerging markets in its stride.

Traders said that was enough to support the view that the Federal Reserve can continue to wind down its stimulus programme, boosting the dollar's attraction against other major currencies.

RBC's Cole pointed to month-end flows being positive for the dollar.

There was also talk in the market that emerging market central banks may buy back dollars.

"That is a possibility," Cole added. "If you've seen intervention to support their currencies then they'd be recycling to replenish dollars (that they'd spent propping up their own currencies)."