* Dollar index scales 1-1/2 year high, euro slides * Fed creates new money market funding facility * Yen rises on deleveraging, Wall Street opens down (Recasts, changes byline, dateline, previous LONDON) By Lucia Mutikani NEW YORK, Oct 21 (Reuters) - The U.S. dollar surged to a 1-1/2 year peak versus a basket of currencies on Tuesday due to strong demand from financial institutions seeking a safe-haven despite a moderation in interbank rates. Analysts said the demand for the greenback was also driven by signs that momentum was building for a second program to stimulate the flagging U.S. economy. Federal Reserve Chairman Ben Bernanke threw his support behind such a package on Monday. There was also speculation that banks needed more dollars to settle credit derivatives tied to the bankruptcy of Lehman Brothers. By contrast, the euro was left on the defensive on the growing perception that policy-makers in the currency zone have scope for aggressive interest rate cuts. The yen rose broadly, reflecting underlying nerves on the global economy's outlook. "The one thing that remains clear is there is still a desire to get U.S. dollars and U.S assets," said Matthew Strauss, senior currency strategist at RBC Capital Markets in Toronto. "Although we have seen the funding situation easing somewhat, especially if we look at the Libor rates, it's still at elevated levels. Financial institutions that have direct exposure to the derivatives market are looking for a safe-haven." The ICE Futures U.S. dollar index climbed to 83.846 .DXY, its highest since March 2007, according to Reuters data. The index, which measures the greenback's value against a basket of six currencies, was last up 1.0 percent at 83.781. The euro dropped to its lowest level since March 2007 at $1.3161, according to Reuters data. It was last down 1.3 percent at $1.3169 . FED CREATES NEW FACILITY The Fed on Tuesday announced the creation of a new funding facility to provide liquidity to money market investors. For details, see [ID:nWEQ000313]. While interbank lending has started to revive from a state of near-paralysis, the dollar and yen benefited as investors continued to liquidate highly leveraged positions. The interbank cost of borrowing dollars, euros and sterling fell across all maturities on Tuesday, according to the British Bankers' Association's daily fixing. Dollar overnight rates were fixed below the Fed's 1.5 percent target for its federal funds rate. Against the yen, the dollar fell 1.0 percent to 100.80 yen . The euro dropped 2.3 percent to 132.82 yen . The yen was boosted as U.S. stock indexes opened more than 1 percent lower due to worries about the profit outlook. "The deleveraging story will continue and remain in place for quite some time," said Audrey Childe-Freeman, senior FX strategist at Brown Brothers Harriman in London. "The other interesting thing coming through is the policy responses to the crisis. I think the U.S. remains ahead on that front." As financial markets regain some poise, analysts said fears about the credit crisis were starting to give way to concerns about economic fundamentals and monetary policy. The Fed's Bernanke on Monday said the economy was expected to be weak for several quarters and there was some risk of a protracted slowdown. Analysts reckon aggressive interest cuts by the U.S. central bank put the economy in a better position to recover quickly compared to its peers around the world. Fed policy-makers meet next week, and economists and investors widely expect another rate cut from the current 1.5 percent after leading global central banks recently acted in concert to cut borrowing costs. The high-yielding Australian dollar fell 3.2 percent to US$0.6827 on expectations of further policy easing from the Reserve Bank of Australia. RBA minutes from its meeting earlier this month indicated there was more room for rate cuts, though not as aggressive as this month's 100 basis point cut. [ID:nSYD393834] (Additional reporting by Veronica Brown in London; Editing by Tom Hals)

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