NEW YORK (Reuters) - The dollar weakened for a second straight session on Thursday, as an easing in extreme risk aversion among investors boosted equities worldwide following a Federal Reserve rate cut the previous session.
Data showing a smaller-than-expected contraction in the U.S. economy in the third quarter underpinned sentiment on risky assets, including higher-yielding currencies, and helped the dollar hold gains versus the yen.
Still, the fall in U.S. gross domestic product in the last quarter was the sharpest contraction in seven years.
"The GDP number is bad but it's not horrible. At this point any number that is not disastrous is considered positive for risky assets and bad for the dollar and yen," said Boris Schlossberg, director of currency research at GFT Forex in New York.
But he was skeptical about the sustainability of the rally in stocks and of high-yielding currencies such as the euro, sterling and the Australian dollar. "These currencies have had a steep short-covering rally in recent days against the dollar and I don't know how much further they can go. There's strong resistance at $1.32 in euro/dollar."
In early New York trading, the euro was up around 0.6 percent at $1.3030 in volatile trade, pulling further away from a 2-1/2-year low of $1.2329 hit this week on electronic trading platform EBS.
The ICE Futures dollar index, which measures the dollar's value against six other major currencies, fell 1 percent to 84.232 .DXY.
Despite its broad losses, the dollar climbed 1.2 percent to 98.65 yen, extending its recovery from a 13-year trough just below 91 yen touched on EBS late last week.
Sterling rose 0.2 percent against the dollar to $1.6453 while the Australian and New Zealand dollars rose roughly 2 percent and 1 percent respectively.
Mirroring the upbeat mood in the currency market, European shares rose 2.5 percent, taking a cue from dramatic gains in shares in Asia, where Japan's Nikkei stocks average .N225 surged nearly 10 percent.
Higher share prices showed some investors had retreated from extreme risk aversion seen after a meltdown in the banking sector triggered waves of selling in past weeks.
The recovery in stocks and high-yielders was triggered by the Fed -- the U.S. central bank -- reducing borrowing costs by a half percentage point to 1 percent on Wednesday and leaving the door open for further easing of monetary policy.
The Fed also approved on Wednesday currency swap lines with central banks in several major emerging countries, making dollars available to help them deal with the credit crunch.
Analysts, however, expressed caution about the market's renewed optimism, saying for instance that the U.S. GDP report was a harbinger of distressing things to come.
"I think the relief over the GDP's headline number will not last long," said Brian Dolan, chief currency strategist at Forex.com in Bedminster, New Jersey.
"The report points to terrible outlooks for U.S. firms and U.S. stocks, so the initial rally should not last and we may be in for a downdraft in risky assets."
The GDP report showed a steep pullback in consumer spending. which fuels two-thirds of U.S. economic growth. It fell at a 3.1 percent annual rate in the third quarter -- the first cut in quarterly spending since the closing quarter of 1991 and the biggest since the second quarter of 1980.
