The dollar steadied above last week's record lows versus the euro on Tuesday as investors chose to hold fire ahead of a widely-expected Federal Reserve interest rate cut.

Sterling hit a one-year low on a trade-weighted basis for a second day, still haunted by funding problems at Northern Rock, Britain's fifth-biggest mortgage lender, which raised concerns other financial institutions could be hit by high interbank lending rates.

Northern Rock's troubles kept risk aversion in the spotlight, hurting the high-yielding Australian and New Zealand dollars and propping up the low-yielding yen.

Market turmoil coupled with a run of below forecast U.S. data have fanned speculation that the Fed will cut the fed funds rate from the current 5.25 percent, but there is uncertainty over whether it will move by 25 basis points or by 50.

Now in the lead up to tonight's announcement it's a little bit quiet and then, depending on what the Fed says, it could be up to two big figures either way on most currencies, said Geoff Kendrick, currency strategist at Westpac.

Analysts reckon that a 25 basis point cut may not be enough to boost equity markets and calm risk aversion.

A 50 basis points cut will probably allow money market rates to calm down and keep equity markets supported...and the euro could move up to $1.40. If we only see 25 ... that would probably be a scenario which favors dollar/yen downside, said Chris Turner, head of FX strategy at ING.

By 7:19 a.m. the dollar was steady at 115.13 yen. The euro was also flat at 159.61 yen.

Sterling hit a one-year low on a trade-weighted basis at 101.9 and set a 17-month low versus the euro at 69.73 pence.

The single European currency was little changed at $1.3862, in sight of last week's record highs around $1.3930.

The euro shrugged off data showing a bigger than expected fall in the German ZEW index for September as worries about market turmoil and the strong euro took their toll on investment sentiment.

FED WATCH

An unexpected fall in U.S. core retail sales, weaker-than-forecast industrial output and a surprise drop in U.S. payrolls for August have boosted the case for lower U.S. interest rates. But the size of the likely rate cut has become unclear.

With foreign investors holding a quarter of all outstanding U.S. government bonds the possibility that Fed easing will reduce foreign appetite for these securities, resulting in higher risk premium for U.S. assets and a weaker dollar, is very real in our view, Barclays Capital said in a client note.

The Fed last cut rates in June 2003, when it lowered them by 25 basis points to 1.00 percent.

The implied chances that the Federal Open Market Committee will slash its benchmark overnight lending rate by one-half percentage point on Tuesday slipped as low as 44 percent from 58 percent on Friday and 76 percent a week ago.

Ahead of the Fed decision, U.S. producer prices data for August and capital flows numbers for July are released.

Market players were also eyeing quarterly results from major U.S. investment banks this week, starting with Lehman Brothers at 8:00 a.m., to see the scope of impact from the credit squeeze.

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