The dollar hit a two-month low against the euro and a basket of major currencies on Thursday as soft inflation and manufacturing data added to concern about the strength of the U.S. economy.

Data showing third straight monthly decline in producer prices came a day after Federal Reserve meeting minutes revealed policymakers think they may need to do more to boost the economy if a sputtering recovery slows any further.

That helped the euro rally to just shy of $1.29 for the first time since May. Debt trouble in the euro zone had pushed it below $1.19 last month, but fairly smooth bond auctions in Greece, Portugal and Spain have since eased concern.

Traders said efforts to cover bets against the euro that have built up in recent months have accelerated its rise, as did demand for overnight euro call options with strikes at $1.2825, $1.2835 and $1.2855.

Positioning and technical considerations suggest a move toward $1.30 is realistic, said Derek Halpenny, head of Europe currency research at BTM/UFJ.

Recent short-covering was sparked by increasingly soft U.S. economic data. Separate reports on Thursday showing declining factor activity in the New York and Mid-Atlantic regions also unnerved markets, as did a report Wednesday showed retail sales fell for a second consecutive month. [ID:nN15208925]

The data is going to give traders further reason to dump the dollar as the risk shifts from Europe to the United States, said Kathy Lien, director of FX research at GFT Forex in New York. Overall, U.S. fundamentals are making the U.S. less attractive to investors.

DOLLAR DOWN BROADLY

The euro rose as high as $1.2895 Thursday and was last changing hands at $1.2870 EUR=, up 1 percent. Traders said demand for overnight euro/dollar call options with strikes at $1.2825, $1.2835 and $1.2855 had facilitated the rally.

The dollar also fell 1.2 percent to 87.35 yen JPY= and hit a three-month low at 1.0432 Swiss francs CHF=. Sterling rose 0.7 percent to $1.5366 GBP=D4, just off a 10-week high.

Citing the weaker U.S. growth outlook, Goldman Sachs now forecasts the euro to trade at $1.22 in three months' time rather than $1.15, as it predicted in June. It's six- and 12-month forecasts are $1.35 and $1.38, respectively, compared to $1.15 and $1.25 a month ago.

Soft economic data has hurt the dollar even as U.S. corporate profits have been surprisingly strong. Investors fear the data hints at slower growth in the second half of 2010.

Over the near term, the dollar is likely to continue to struggle if data continues to come out towards the weaker end of expectations. That would tend to add to the dollar's heavier tone, said Joe Manimbo, analyst at Travelex Global Business Payments in Washington.

Strategists said technical indicators were flashing a breakdown of the dollar's recent trend higher. The dollar index .DXY, which measures the greenback against six major currencies, hit a two-month low and passed the 38.2 percent retracement of an trend up that began in November and peaked in early June.

(Additional reporting by in Nick Olivari and Wanfeng Zhou in New York and Jessica Mortimer in London; Editing by )

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