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FOREX-Sinking yields puts euro on track for biggest weekly drop in 3 weeks

Saikat Chatterjee

* Graphic: World FX rates in 2019 http://tmsnrt.rs/2egbfVh

LONDON, July 5 (Reuters) - The euro fell a fifth of a percent against the dollar on Friday and is set for its biggest weekly drop in three weeks as a relentless slide in government bond yields forced investors to look for higher-yielding assets elsewhere.

Falling yields globally has also raised concerns that policymakers, especially the European Central Bank, may have limited firepower in boosting economic growth, a factor that has weighed on the single currency.

"We have seen little evidence that unconventional tools can stimulate or sustain economic growth," said David Lafferty, chief market strategist at Natixis Investment Managers.

"The global recovery and expansion has been historically long but has also been historically weak."

Germany's 10-year Bund yield breached the European Central Bank's deposit rate of -0.40%, a level analysts say acts as a psychological barrier even though shorter-dated German bond yields already trade well below it.

But despite the fall in yields -- German bond yields have dropped 65 bps this year -- the single currency has been well supported at around $1.12, a level it has traded above since early June and 1.5% above a 2019 low of $1.1055 hit in late May.

Analysts say the euro's surprising strength is due to concerns that any stimulus from the ECB after years of negative policy rates and multiple rounds of bond purchases may be dwarfed by likely big rate cuts from the Fed.

"More easing from the next ECB chief is already priced into bond markets and it will take a significant surprise for the euro to move from current levels," said Ricardo Evangelista, a senior analyst at brokerage ActivTrades.

On Friday, the single currency edged 0.2% lower at $1.1265 and is on track for a weekly loss of 0.9% versus the dollar, its biggest weekly loss since mid-June.

RATE CUTS

Expectations of big U.S. rate cuts will not be shaken by jobs data due later, with economists polled by Reuters predicting U.S. non-farm payrolls to have increased by 160,000 in June from 75,000 in May.

Though markets are expecting as much as three rate cuts by the end of 2019, interest rate differentials between benchmark 10-year debt in the United States and Germany stands at a chunky 235 basis points.

The dollar index against a basket of six major currencies stood little changed at 96.823, having spent the previous day in a tight range as U.S. financial markets were closed for the Independence Day holiday.

The Australian dollar was a shade weaker at $0.7016 after climbing to a two-month high of $0.7048 the previous day.

The Aussie has advanced 1.4% this week with expected rate cuts from the Fed and the ECB helping shift some of the focus away from the Reserve Bank of Australia's own easing bias.

The pound struggled near a two-week low of $1.2557 plumbed on Wednesday.

(Reporting by Saikat Chatterjee; Editing by Toby Chopra)