FOREX-Euro falls on soft price data, dollar set for best month since May

* Weak euro zone inflation data spur view on more ECB action

* Dollar index poised for best monthly gain in 8 months

* Emerging market jitters, Japanese inflation boost yen

* Canadian dollar falls to 4-1/2 year low on sluggish growth

(Updates market action, adds quote, changes dateline)

By Richard Leong

NEW YORK, Jan 31 (Reuters) - The euro fell on Friday as soft euro zone inflation data rekindled concerns the European Central Bank may have to act to combat deflation, while the dollar strengthened on mildly encouraging data to close out its best month since May.

Nagging worries about emerging market woes spreading underpinned safe-haven buying for the yen.

"The focus on the euro is that we could see a policy response from the ECB next week," said Shaun Osborne, chief foreign exchange strategist at TD Securities in Toronto.

Euro zone inflation data on Friday showed a surprise drop to 0.7 percent year-on-year in January. Analysts had expected a rise to 0.9 percent. News Search ID:nL5N0L51ND

The fall could be a trigger for further easing by the ECB, which holds its policy review next week, to sustain a fragile recovery and ward off a falling price spiral that could cripple the economy for years.

The euro fell 0.5 percent against the dollar at $1.3484

EUR= after touching its lowest level since late November.

The single currency also hit a two-month trough against the yen, last down 0.9 percent against the Japanese currency at 137.97 yen EURJPY= .

The euro is on track to suffer its biggest monthly drop versus the dollar in 11 months and the steepest monthly decline against the yen since July 2012.

Trading volumes were light with large parts of Asia on holiday for the Lunar New Year.

Meanwhile, risk aversion hit commodity-related currencies, with the Canadian dollar falling to a 4-1/2-year low. The loonie last traded at C$1.1176 CAD=D4 per dollar in the wake of weaker-than-expected data on Canadian growth in November.

News Search ID:nL2N0L50R7

The sell-off in the euro and emerging market currencies like the Turkish lira TRY= and South African rand ZAR= this week has benefited the yen - last year's weakest major currency - as the dollar fell 0.6 percent to 102.08 yen JPY= on Friday.

There were large month-end option expiries at the 102.25 and 103 yen, according to one trader.

Another boost to the yen was Japan's core consumer price inflation, which accelerated to 1.3 percent in January, the highest level in five years. JPCPI=ECI News Search ID:nL3N0L40ZC

GOOD JANUARY FOR DOLLAR

The dollar index =USD rose 0.2 percent to 81.23, 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 stride. News Search ID:nL2N0L324Y

The dollar index has risen more than 1 percent in January and is poised for its biggest month gain since May.

Friday's data on U.S. consumption, Midwest manufacturing and consumer sentiment reinforced the notion the world's biggest economy has some cushion to weather the emerging markets turmoil and reduced stimulus from the Federal Reserve. News Search ID:nL2N0L50N2

"The dollar has emerged from this tapering better than we had thought," TD's Osborne said.

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

"That is a possibility," said Adam Cole, head of G10 FX strategy at RBC Capital in London. "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)."

Data from the Federal Reserve late Thursday hinted some foreign central banks sold their Treasuries holdings to raise cash and buy their own currencies on the open market in a bid to stabilize them from further damage due to emerging market jitters.

Overall foreign holdings of securities such as Treasuries, mortgage-backed securities and agency debt at the U.S. central bank fell by $20.77 billion to $3.325 trillion in the week ended Wednesday, led by a $20.66 billion drop in Treasury holdings. It was the largest weekly decline for both since June, the Fed data showed.

(Additional reporting by Laurence Fletcher in London and Ian Chua in Sydney; Editing by Chris Reese)

((richard.leong@thomsonreuters.com)(+1 646 303 6313)(Reuters Messaging: richard.leong.thomsonreuters.com@thomsonreuters.net)(Twitter @RichardLeong2))

 
((Currency bid prices at 10:54AM (1554 GMT) 
Description    RIC    Last    U.S. Close 
 Previous  
 Session    Pct Change    YTD Pct 
 Change    High Bid    Low Bid 
Euro/Dollar    EUR=    $1.3480    $1.3555    -0.55%    -1.93%    +1.3568    +1.3480 
Dollar/Yen    JPY=    102.0900    102.7000    -0.59%    -2.91%    +102.9400    +102.0400 
Euro/Yen    EURJPY=    137.65    139.18    -1.10%    -5.15%    +139.5000    +137.6200 
Dollar/Swiss    CHF=    0.9060    0.9026    +0.38%    +1.48%    +0.9066    +0.9009 
Sterling/Dollar    GBP=    1.6432    1.6484    -0.32%    -0.75%    +1.6497    +1.6429 
Dollar/Canadian    CAD=    1.1159    1.1155    +0.04%    +5.08%    +1.1224    +1.1155 
Australian/Dollar    AUD=    0.8718    0.8790    -0.82%    -2.19%    +0.8823    +0.8695 
Euro/Swiss    EURCHF=    1.2214    1.2237    -0.19%    -0.46%    +1.2245    +1.2212 
Euro/Sterling    EURGBP=     0.8200    0.8219    -0.23%    -1.17%    +0.8242    +0.8187 
NZ Dollar/Dolar    NZD=    0.8080    0.8165    -1.04%    -1.54%    +0.8181    +0.8064 
Dollar/Norway    NOK=    6.2963    6.2499    +0.74%    +3.79%    +6.3023    +6.2416 
Euro/Norway    EURNOK=    8.4893    8.4728    +0.19%    +1.81%    +8.5213    +8.4578 
Dollar/Sweden    SEK=    6.5445    6.5135    -0.07%    +1.90%    +6.5595    +6.5139 
Euro/Sweden    EURSEK=    8.8251    8.8313    -0.07%    -0.46%    +8.8800    +8.8083 
     
     
All spots FX=  
Tokyo spots AFX=  
Europe spots EFX=  
Volatilities FXVOL=  
Tokyo Forex market info from BOJ TKYFX World central bank news CEN 
Economic Forecasts... ECON   Official rates...INT/RATE 
Forex Diary.......MI/DIARY   Top events........M/DIARY 
Diaries...........DIARY Diaries Index........IND/DIARY 
Press Digests.....PRESS Polls on G7 economies..SURVEY/ 
European markets......MARKETS/))))

Keywords: MARKETS FOREX