FOREX-Dollar turns defensive on retail sales disappointment

* Dollar softer across the board after retail sales data

* Sales post biggest monthly drop in 11 months in Dec

* U.S. yields reach new lows, undermining USD

By Ian Chua

SYDNEY, Jan 15 (Reuters) – The dollar nursed losses early on Thursday, having retreated across the board after a surprisingly big fall in U.S. retail sales pulled U.S. yields sharply lower.

Investors took some profits on long dollar positions as retail sales recorded their largest decline in 11 months in December.

The disappointing data led the market to push out yet further the likely date for the Federal Reserve’s first interest rate hike, which many analysts had suspected could come in June.

Fed fund futures now have barely one move of 25 basis points priced in by year-end.

Reflecting that uncertainty, the benchmark U.S. 10-year yield reached a 20-month trough of 1.784 percent, while the 30-year yield touched an all-time low of 2.395 percent.

As a result, the dollar fell as far as 116.07 yen, a level last seen on Dec. 16. It later managed to recover some ground to last stand at 117.33 in Asian trade. The euro pulled up to $ 1.1789, from a nine-year trough of $ 1.1728.

All that left the dollar softer against a basket of major currencies. The dollar index was at 92.086, off a nine-year high of 92.528 set a week ago.

“Our economists believe the retail numbers were likely distorted by seasonal effects and do not fairly reflect the health of underlying activity,” analysts at BNP Paribas wrote in a note to clients.

“Still…it will likely take significant improvement in data to restore confidence in Fed expectations and bring yields back to their previous highs.”

Traders said the dollar index is unlikely to fall too far in the lead up to the European Central Bank Jan. 22 policy review, given feverish speculation the bank will launch a large-scale program of sovereign-bond buying.

The ECB on Wednesday won crucial backing for such purchases from a top EU legal adviser, who said a 2012 ECB bond-buying blueprint did not break EU law.

Given that outcome, the common currency struggled against the yen. It dipped to a fresh 2-1/2 month low of 137.02 , extending a pullback from a six-year high of 149.79 set last month.

A standout currency was the Norwegian crown, which jumped nearly 2 percent against the greenback, further supported by a rare bounce in oil prices. The dollar last traded at 7.6225 crowns, having fallen from 7.7761.

Both U.S. and Brent crude rallied more than 4 percent, snapping a four-day losing streak and perhaps a sign prices may have finally found a tentative bottom.

The Australian dollar also staged a remarkable recovery against the dollar, pushing back up to $ 0.8146 from $ 0.8068.

The Aussie, usually used as a proxy for global growth, was initially spooked by a sharp drop in the price of copper, traditionally seen as a barometer for demand.

Local employment data due at 0030 GMT is the next test for the Aussie, although recent price action suggested there is good support below 81 cents.

(Editing by Grant McCool)