FOREX-Dollar edges back from four-month high as UK, EU PMIs calm nerves

* Graphic: World FX rates

LONDON, March 24 (Reuters) - The dollar edged down from four-month highs on Wednesday as better-than-expected purchasing manager surveys from Britain and Europe offset concerns over a third COVID-19 wave in Europe, potential U.S. tax hikes and rising tensions between the West and China, which sapped risk appetite overnight.

Euro zone business activity unexpectedly grew this month, a preliminary survey showed, but with much of Europe suffering a third wave of coronavirus infections and renewed lockdown measures, that may not last through April.

Factories ramped up output at the fastest monthly pace in over 23 years, countering a continuing slowdown in the dominant services industry, which is more vulnerable to lockdowns and the region’s slow vaccine rollout.

IHS Markit’s flash composite PMI, seen as a good guide to economic health, climbed above the 50 mark separating growth from contraction, to 52.5 in March compared with February’s 48.8, its highest since late 2018.

The PMI saw the dollar index pull back from a four-month high of 92.608 hit in early London trade, trading at the 92.454 mark around midday.

“(COVID-19 third wave concern) was the real driving force ... but ultimately we’ve seen that negativity pushed back by the context of the flash PMI’s we’ve seen this morning across the euro zone and the UK, which have been much more constructive,” said Jeremy Stretch, head of CIBC FX strategy.

“Markets are looking for forward-looking indicators and this is reflective of a presumption that Q2 will be materially better than Q1 and that plays back into the reflation narrative, which was being questioned by the market in the overnight session.”

Stretch added that he doesn’t expect the dollar to strengthen materially from here, and that he expects commodity currencies such as the Australian and New Zealand dollars to gain.

The index that measures the dollar’s strength against a basket of peer currencies is up nearly 3% year-to-date, confounding widely held expectations among analysts for a decline.

Strategists at BCA Research said they believe the U.S. dollar is experiencing a “counter-trend rally within a bear market.”

“Over the near-term, the dollar benefits from two supports. First, the U.S. growth will outperform thanks to generous fiscal policy and the country’s lead in vaccinations. Second, the NASDAQ and other highflying global equities have been correcting since February, creating some risk-off undertones that help the counter-cyclical greenback.”

“However, real interest rate differentials will ultimately determine the currency’s cyclical outlook. The Fed’s commitment to maintaining an accommodative policy will cap upside to US real rates at the short end of the curve. This will prevent a sharp appreciation in the dollar.

The euro hit a four-month low of $1.1812 after Germany extended a lockdown and urged its citizens to stay at home during the Easter holiday.

The overnight flight to safety got an additional nudge when Treasury Secretary Janet Yellen told lawmakers that future tax hikes will be needed to pay for infrastructure projects and other public investments.

Yellen and Fed Chair Jerome Powell are also scheduled to testify to the Senate Banking Panel on Wednesday.

Human rights sanctions on China imposed by the United States, Europe and Britain, which prompted retaliatory sanctions from Beijing, added to market concerns overnight.

The safe-haven yen, which gained in Asian trade, weakened 0.1% by the start of trading in London. Australia’s dollar - considered a liquid proxy for risk - weakened further on Wednesday.

The Aussie slipped to as low as $0.7582, a level not seen since Feb. 5., before recovering.

The British pound weakened as far as $1.3675, also the lowest since early February.

In cryptocurrencies, bitcoin gained 4.7% to $56,870, off a record high of $61,781.83.

Reporting by Ritvik Carvalho; additional reporting by Kevin Buckland in Tokyo; editing by Larry King