Market LookBeck II

(Reuters) - The U.S. dollar dropped against the euro and Japanese yen on Thursday as a deluge of data highlighted vulnerabilities in the U.S. economy and curbed expectations the Federal Reserve will scale back its bond-buying program any time soon.

The dollar snapped a five-day advance against the euro after data showed the number of Americans filing new claims for unemployment benefits climbed last week to the fastest pace in six months, raising concerns about government austerity measures.

The Fed has made it clear that monetary policy will remain accommodative until they see broad and sustained growth in jobs.

Other data showed a sharp drop in gasoline costs led U.S. consumer prices to tumble in April by the most in over four years. Meanwhile, ground-breaking for new U.S. homes fell more than expected in April from an almost five-year high.

"The dollar was on an uptrend headed into today's number, mostly due to an optimistic view of the U.S. economy," said Vassili Serebriakov, FX strategist at BNP Paribas in New York.

"The Fed has fallen short of its mandate on jobs and inflation, so the data highlights the need for further accommodation," he said. "The data also warrants a reconsideration of the bullish dollar view."

The euro was last up 0.1 percent at $1.2897, above a six-week low of $1.2842 touched on Wednesday when data showed the euro zone's economy contracted for a sixth consecutive quarter.

"The dollar was overstretched in valuation and positioning, so it makes sense that we are now seeing a bit of an unwind," Serebriakov said.

Dollar losses accelerated in midmorning North American trade after a survey showed factory activity in the U.S. mid-Atlantic region contracted in May as new orders fell to their lowest level in almost a year.

Dallas Federal Reserve Bank President Richard Fisher reacted to the U.S. inflation data.

A slowdown in U.S. inflation was benign and could "unleash" consumer spending, Fisher said, adding that he was not worried about the risk of deflation.

"The data today was broadly weak and overall it drives home the fact that the economic backdrop remains uneven, and that will keep the Fed's foot on the accelerator by continuing to engage in accommodative policy," said Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York.

"Talk about the Fed scaling back its asset purchases is premature, but we do expect it to happen sometime at the turn of the year," he said.

Meanwhile, falling prices in Germany and France highlighted the risk of deflation in the euro zone, which slipped into its longest ever recession at the start of this year, increasing the risk of more European Central Bank interest rate cuts.

Traders said investors were eager to buy dips in the dollar, which was expected to gain further while the yen continued to weaken following April's aggressive Japanese monetary easing.

Against the yen the dollar last traded down 0.1 percent at 102.16 yen, down from a session peak of 102.68 yen. The dollar touched a peak of 102.76 yen on Wednesday, its strongest since late 2008, according to Reuters data.

The Australian dollar remained near an 11-month low with the session trough at US$0.9795. It was the first dip below 98 U.S. cents for the Australian dollar since June 2012, using Reuters data.

Traders cautioned that the U.S. initial jobless claims and other data were not reasons to overreact, particularly ahead of the release of the Fed policy meeting minutes from the April 30-May 1 meeting on Wednesday.

"We're all looking to the FOMC minutes next week," said Andrew Dilz, currency trader at Tempus Inc in Washington.