By Elizabeth Howcroft

LONDON (Reuters) – The dollar steadied, the euro slipped and riskier currencies remained strong on Monday, as currency markets were torn between optimism about U.S. stimulus plans, and the reality of slow vaccine rollout and the economic impact of lockdowns in Europe.

Market sentiment had turned more cautious at the end of last week as European economic data showed that lockdown restrictions to limit the spread of the virus hurt business activity, dragging stocks lower.

The safe-haven dollar declined gradually overnight, and riskier currencies strengthened. It then recovered some losses after European markets opened, and was at 90.224 against a basket of currencies at 1152 GMT, flat on the day.

On one hand, market sentiment is supported by hopes for President Joe Biden’s $1.9 trillion fiscal stimulus plans, as well as the expectation that central banks will continue to provide liquidity.

But, in Europe, the extent of the risk appetite was limited by a lack of progress in rolling out the COVID-19 vaccine as well the economic impact of lockdown measures.

German business morale slumped to a six-month low in January, surprising market participants who had expected the survey to show a rise.

“It’s very much a case of hopes for the future against the reality of the first quarter of this year which is going to still prove to be fairly troubled,” said Jeremy Stretch, head of G10 FX strategy at CIBC Capital Markets.

“For now at least, the optimism that we’re hoping for has been somewhat delayed and that has taken a little bit of steam out of the euro and just put a little bit of support back in the dollar but ultimately I think it is still a case of those high-beta commodity currencies, reflation currencies, will continue to perform well,” he said.

Analysts expect a broad dollar decline during 2021. The net speculative short position on the dollar grew to its largest in ten years in the week to Jan. 19, according to weekly futures data from CFTC released on Friday.

The U.S. Federal Reserve meets on Wednesday and Fed Chair Jerome Powell is expected to signal that he has no plans to wind back the Fed’s massive stimulus any time soon – news which could push the dollar down further.

“The process of tapering QE is likely to be a gradual process which could last throughout 2022, and then potentially be followed by the first rate hikes later in 2023,” wrote MUFG currency analyst Lee Hardman.

“In these circumstances, we continue to believe that it is premature to expect the US dollar to rebound now in anticipation of policy tightening ahead, and still see scope for further weakness this year,” he said.

The euro was down around 0.1% against the dollar, at $1.2153 at 1207 GMT. At the European Central Bank meeting last week, President Christine Lagarde said the bank was closely watching the euro. The euro surged 9% last year versus the dollar and reached new two and a half year highs earlier in January.

But despite this verbal intervention, traders remain bullish on the euro, expecting the bar for a rate cut to be high.

Elsewhere, the Australian dollar, which is seen as a liquid proxy for risk, was up 0.2% at 0.7726 versus the U.S. dollar at 1208 GMT.

The New Zealand dollar was up 0.5%, while the commodity-driven Norwegian crown was up 0.2% the euro.

The safe-haven Japanese yen was flat on the day at 103.815 versus the U.S. dollar.

Graphic: USD, https://fingfx.thomsonreuters.com/gfx/mkt/qmypmyjdxpr/USD.png

(Reporting by Elizabeth Howcroft, editing by Ed Osmond and Chizu Nomiyama)