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NEW YORK (Reuters) - The dollar dropped across the board on Friday, hitting a 7-1/2-month trough against the safe-haven Swiss franc, dented by the prospect of a U.S. government shutdown next week and a lack of clarity over when the Federal Reserve will scale back stimulus.
The U.S. government braced for a possible partial shutdown of operations on October 1 as Congress struggled to pass an emergency spending bill that Republicans want to use to achieve Tea Party-backed goals, such as defunding the new healthcare reform law.
Congress also faces the hard task of raising the limit on federal borrowing authority. Without a debt limit increase by October 17, Treasury Secretary Jack Lew has warned, the United States government would have a difficult time operating and paying creditors.
The more immediate focus was the looming U.S. budget deadline.
"As this deadline approaches, investors are stepping up their sale of dollars on the growing concern that a government shutdown will undermine the quality of U.S. assets and lead to a retrenchment in U.S. growth," said Kathy Lien, managing director at BK Asset Management in New York.
The dollar index, which tracks the greenback against a basket of six major currencies .DXY, was last down 0.3 percent to 80.284, not far from a seven-month low of 80.060 struck after the Fed last week decided to maintain its bond-buying program at $85 billion a month.
On the week the index dropped about 0.2 percent, its third straight weekly loss. For September it is down around 2.2 percent.
Currency speculators cut their bets in favor of the U.S. dollar to the lowest net long in seven months in the latest week, according to data from the Commodity Futures Trading Commission released on Friday.
The dollar fell to 0.9018 Swiss franc, its lowest since early February, with the franc also boosted by solid Swiss sentiment data. It was last down 0.5 percent at 0.9058.
"Month-end rebalancing and hedging activity are having enough impact to move the dollar in an environment of limited volume," said Sebastien Galy, foreign exchange strategist at Societe Generale in New York.
Against the dollar, the euro rose 0.2 percent to $1.3518. The euro dominates the composition of the dollar index.
"Some profit-taking in U.S. equities was likely behind the run-up on euro/dollar in the morning and this pressure is fading as algorithms are not finding enough momentum to continue the break-out in euro/dollar," Galy said. "Next week's U.S. nonfarm payrolls report will likely lead the dance for 10-year yields."
"Downward pressures may still initially support euro/dollar, before the market realizes it is priced for perfection, whereas signs of deflation for example in Spain express a different reality," he said.
Sterling rose to $1.6137 against the dollar, a one-week high, after Bank of England Governor Mark Carney was quoted as saying he saw no need for more bond-buying by the central bank given signs of recovery in the British economy.
Beyond the budget impasse and month- and quarter-end flows, investors are focused on the Fed's next meetings in October and December, with some expecting the U.S. central bank to hold off on reining in stimulus until early 2014 to make sure the U.S. recovery is firmly on track.
"While we maintain a positive medium-term outlook for the dollar, signs of more definitive upside momentum for the greenback will have to wait until Washington has overcome its budget hurdles and until U.S. economic data suggests that the U.S. economy is sufficiently self-sustaining for quantitative easing to be reduced," said Jane Foley, senior currency strategist at Rabobank in London.
The dollar fell to a one-week low against the yen after Japanese Finance Minister Taro Aso said he was not thinking of lowering the effective corporate tax rate now. The remarks surprised investors who had positioned for a weaker yen on expectations of more fiscal stimulus to prop up the economy.
The issue of whether Japan will lower the effective corporate tax rate has been weighing on the yen, which has slid this year on the back of Japanese Prime Minister Shinzo Abe's push to reflate the economy through steps such as aggressive monetary stimulus and pro-growth structural reforms.
"The government will likely implement some form of fiscal stimulus but clearly it won't include a corporate tax rate cut immediately," said Derek Halpenny, European head of global market research at Bank of Tokyo Mitsubishi.
The dollar fell as low as 98.07 yen and last traded down 0.7 percent at 98.24 yen. On the week the dollar dropped about 1.2 percent, its second straight weekly loss, according to Reuters data.
Additional reporting by Nick Olivari and Gertrude Chavez-Dreyfuss; Editing by James Dalgleish