May 30, 2018 / 3:30 PM / 22 days ago

FOREX-Dollar falls, euro recovers as Italy tries to end turmoil

* Euro rebounds after Tuesday's big drop

* Dollar falls back from 6-1/2-month highs

* Canadian dollar rises after Bank of Canada announcement

* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh (Updates analyst comments, exchange rates, BoC news)

By Kate Duguid

NEW YORK, May 30 (Reuters) - The U.S. dollar fell on Wednesday as the euro recovered from 10-month lows after reports that Italy's biggest party would make a renewed attempt to form a coalition government and end months of political turmoil.

An attempt by two anti-establishment parties to form a new government in Italy collapsed over the weekend, raising the prospect of an early election. Markets feared that election would become a de facto referendum on Italy's use of the euro.

A source close to 5-Star, the single largest party in the new parliament, said it would try again to form a coalition with the right-wing League. Without a deal, sources said President Sergio Mattarella could dissolve parliament in the coming days and send Italians back to the polls as early as July 29.

The euro rallied and Italian government bond yields settled below multi-year highs after Tuesday's market slide. The dollar index, which tracks the greenback against a basket of six currencies, was down nearly half a percent on Wednesday to a session low of 94.236, below Tuesday's 6-1/2-month high. The dollar remained steady against the yen.

"We're seeing a relief trade today. Markets passed through the panic from yesterday so everything that sold off hard is climbing back, the euro in particular," said Greg Anderson, global head of FX strategy at BMO Capital Markets in New York.

A smooth auction of Italian government debt also helped soothe market jitters.

The single currency, which plunged to a 10-month low of $1.1510 on Tuesday, rose as much as 0.9 percent to a session high of $1.1647 on Wednesday. It remains down 4 percent this month against the dollar.

The Canadian dollar rose as much as 1.2 percent on Wednesday after the country's central bank held interest rates steady but suggested that it could raise rates soon, possibly as early as July.

"The bottom line is that they’ll be hiking in July unless some surprise occurs," Anderson said. He noted that the loonie on Wednesday "appreciated in an important way, not just against the dollar, but across all axes, for example, Aussie/CAD." (Reporting by Kate Duguid and Tommy Wilkes Editing by Paul Simao)

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