NEW YORK, June 23 (Reuters) - The dollar was lower against the euro ahead of a decision on interest rates from the U.S. Federal Reserve, while sterling rose sharply as investors continued to view the UK budget positively.

The Fed is expected to keep rates on hold and restate its intention to keep interest rates near zero for an extended period.

While that could is seen as a negative for the dollar with rates higher elsewhere, gains in the euro were capped by investor concern about the euro zone banking system and the potential for economic stress.

The Australian dollar gained against the U.S. dollar as Australian Prime Minister Kevin Rudd agreed on Wednesday to a challenge to his leadership.

This week has been more cautious with the Fed this afternoon keeping many investors on the sidelines, said Joe Manimbo, a senior market analyst at Travelex Global Business Payments in Washington.

In early New York trade, the euro was up 0.1 percent at $1.2281 EUR=, having dipped to $1.2244 on electronic trading platform EBS EUR=EBS. Bids are touted at $1.2245 and offers $1.2310.

Technical analysts were looking for a daily close under $1.2255. That level marks a 38.2 percent Fibonacci retracement of the euro's recent rally from its four-year low of $1.1876 hit in early June on trading platform EBS to a one-month high of $1.2490 marked on Monday.

Reaction was muted to the euro zone purchasing managers' survey, where the composite index dipped to 56.0 in June from 56.4 the previous month.

Worries about the euro zone's banking sector returned after French bank Credit Agricole's (CAGR.PA) write-down on its ailing Greek unit Emporiki (CBGr.AT).

That followed Fitch's rating cut of French bank BNP Paribas and S&P's raising of estimates for loan losses for Spain's banking sector on Monday.

Against the yen, the dollar fell 0.4 percent to 90.17 yen JPY=, earlier falling to its lowest level since May 27.


Sterling extended gains after minutes from the Bank of England's June meeting showed an unexpected split, with Monetary Policy Committee member Andrew Sentance voting for a 25 basis point rate increase. [ID:nBOE004238]

The pound rose to a six-week high against the dollar GBP= and last traded at $1.4921, up 0.8 percent on the day.

It's clearly very surprising, someone voting for a hike. Sentance, however, has never made any secret of being on the hawkish side on inflation, said Alan Clarke, economist at BNP Paribas. I don't think it will lead to a hike.

Earlier the Swiss franc rose an all-time high against the euro of 1.3585 francs on trading platform EBS EURCHF=EBS. Traders said option barriers were in place at 1.3575, 1.3550 and 1.3500 with large stops lurking below.

Reuters data shows a record euro low of 1.3586 francs EURCHF=.

The Australian dollar rose 0.3 percent at $0.8748 AUD=, after Prime Minister Rudd agreed to a request from his deputy Julia Gillard for her to challenge for the leadership and called a vote of ruling party lawmakers for Thursday morning at 2300 GMT.

Gillard, if successful, would become Australia's first woman prime minister. Reports that Rudd's leadership was in doubt have been circulating for a few days.

Though news that China will allow the yuan to appreciate has faded from investor focus, the South Korean won has sharply increased this week against the dollar on the back of the news. The dollar is down 1.2 percent against the won for the week to date. KRW=. (Editing by Padraic Cassidy)