By Chisa Fujioka
TOKYO, Oct 26 - The dollar held up on Friday, heartened by U.S. stock gains overnight despite economic data cementing fears the world's biggest economy was in recession.
Wall Street staged a bold turnaround on Thursday, with the Dow Jones industrial average <.DJI> climbing 1.25 percent to its strongest finish since September 10, the day before the devastating attacks in New York and Washington.
"The U.S. data was pretty bad, but stocks reflected hopes for a strong economic recovery next year and the dollar is following," a Japanese city bank trader said.
"Much of the negatives are factored into the market already, and the dollar could well test higher in coming months."
U.S. data showed the number of Americans signing up for jobless benefits rose last week, while orders for costly U.S. durable goods and existing home sales plunged in September.
While the dollar displayed a knee-jerk reaction to the data overnight, it soon recouped ground and remained relatively unscathed in Tokyo.
Traders saw the dollar supported by hopes that U.S. monetary and fiscal measures could lead to an economic recovery next year. The data strengthened expectations the Federal Reserve will cut interest rates at its next meeting on November 6.
By late morning, the dollar stood at 122.82/83 yen from 122.90 yen in New York, though off a fresh two-month high of 123.37 overnight.
Traders said the dollar was also helped by the yen, which looks increasingly shackled by Japan's flagging economy.
Data on Friday showed that Japan's consumer prices fell 0.8 percent in September from a year earlier, a 24th straight month of decline. Separate numbers revealed that retail sales slumped anew.
The data came a day after Japan's government and central bank said they were preparing bearish economic forecasts to reflect the global slowdown exacerbated by last month's air attacks.
The Bank of Japan will hold a regular policy-setting meeting on Monday, but it looked likely to hold back on making any move as it waits for the government to play its part in rescuing the recession-bound economy.
"We can't see any positive factors for Japan, although that's nothing new to the market," said Masayuki Yamamoto, research analyst at Bank of America.
"The U.S. regained favourable sentiment, but the view on Japan has not changed. That's also taking a toll on the yen," he said.
EURO LOOKS AHEAD
The euro was higher at 89.35/36 cents from 89.21 cents offshore, despite a decision by the European Central Bank (ECB) to hold off on a growth-boosting rate cut.
ECB council member and Bundesbank President Ernst Welteke defended the bank's decision in an interview with Germany's Die Welt daily, saying its independence should not be questioned.
He added that political pressure would not spur a cut in rates.
Traders said the move was mostly expected and the single currency would see minimal damage with the market betting on an ECB move in coming months.
"I think the impact of the ECB's decision was limited as the market still expects it will cut rates by 50 to 75 basis points in the next two to three months," said Bank of America's Yamamoto.
Against the yen, the single currency stood at 109.68/83 yen from 109.62 yen in late offshore trade.