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NEW YORK (Reuters) - The euro retreated from a three-week high against the dollar on Thursday as weak sentiment data increased concerns about the economic outlook for the euro zone, though losses were limited by the Federal Reserve pledging to be open on more stimulus.
Following a two-day policy meeting that finished on Wednesday Federal Reserve Chairman Ben Bernanke said policymakers were ready to launch another round of bond buying if the U.S. economy weakened.
The statement weighed broadly on the dollar, pushing it to a three-week low against the euro of $1.3263, before the common currency slipped on data showing euro zone economic sentiment fell more than expected in April.
U.S. initial weekly jobless claims showing a weaker pace of healing in the labor market sent the dollar to a one-week low against the yen and the euro to a session low against the dollar.
"The main catalyst for volatility this week was FOMC," said Kathy Lien, director of FX research at GFT in Jersey City, New Jersey. "Bernanke's dovishness drove the euro/dollar to a fresh 3 week high but the pair has struggled to extend its gains since then."
The euro was last down 0.1 percent on the day at $1.3213 after falling to a session low of $1.3199, with traders reporting selling by hedge funds. Option expiries were also cited around $1.32.
Peripheral bond yields rose and with the threat of political instability from elections in France, Greece and the Netherlands hanging over the euro zone, investors were keen to sell the common currency at higher levels.
Still, the dollar struggled to push higher against most currencies following the Fed's statement. The U.S. central bank reiterated that interest rates were unlikely to rise before late 2014.
"When we look at the global environment it's probably a bit more positive following the Fed yesterday. The fact they are still maintaining a very dovish stance and not taking any risks with the recovery process will help some of the higher beta currencies," said Ian Stannard, head of European FX strategy at Morgan Stanley in London.
The Canadian dollar and the British pound hit seven-month highs against the U.S. currency, as the central banks of Canada and Britain - in contrast to the Fed - are seen moving away from further stimulus.
Sterling rose to a peak of $1.6206, according to Reuters data, while the U.S. dollar was last little changed against the Canadian currency at C$0.9834, having earlier fallen as low as C$0.9802.
The Fed's bond-buying programme is negative for the dollar as it boosts supply of the currency.
"The key takeaway from the Fed is that they are still worried about unemployment and Bernanke will not raise rates until 2014. So the dollar stays soft," said Geoff Kendrick, currency strategist at Nomura In London.
Fresh projections released by the Fed also showed that policymakers' support for a rate hike before 2014 had not increased from January, disappointing dollar bulls who had hoped for the possibility of an earlier exit from its loose monetary policy.
Nomura's Kendrick said the euro was unlikely to rise much but would not fall sharply because of the dollar's struggles. He recommended investors sell one-month euro/dollar option volatilities and go long on carry trades.
With the Fed's dovish bias likely to curb large swings in euro/dollar, investors could instead fund positions in higher-yielding currencies by borrowing in dollars or yen, where rates are near zero and more stimulus is possible.
The dollar eased 0.7 percent against the yen to 80.71 yen, following the lacklustre U.S. claims and euro zone sentiment data.
"This was a disappointing number and offers more evidence that the labor market continues to lose traction," said Joe Manimbo, senior market analyst, Western Union Business Solutions in Washington. "For the dollar, this should add to the risk-off feel in the markets."
It stayed in a 80.30-81.80 yen range seen in the past few sessions ahead of the BOJ's policy meeting on Friday and the Japanese currency was seen as unlikely to make much headway ahead of the meeting.
Sources familiar with the central bank's thinking said the BOJ is likely to ease monetary policy on Friday by boosting asset purchases by up to 10 trillion yen.
Some traders said investors are already bearish on the yen as further BOJ easing has been talked about for weeks, leaving room for the yen to rebound. Others said the BOJ is likely to stay under pressure to ease even after Friday's meeting.
Reporting By Nick Olivari; Additional reporting by Julie Haviv; Editing by Chizu Nomiyama