* Dollar index erases daily losses but still not far above 8-month low
* No resolution yet to U.S. budget talks; debt ceiling risk looms
* Minutes of Fed's Sept policy meeting next in focus
By Lisa Twaronite and Ian Chua
TOKYO/SYDNEY, Oct 9 (Reuters) - The dollar got some relief against the yen on Wednesday from news President Barack Obama has tapped dovish Federal Reserve Vice Chairwoman Janet Yellen to head the U.S. central bank, though the U.S. budget impasse kept the greenback near an eight-month trough against a basket of currencies.
Obama will announce his selection of Yellen later on Wednesday. If confirmed by the U.S. Senate, Yellen would replace Ben Bernanke, whose second four-year term ends on Jan. 31.
Against the safe-haven yen, the dollar rose about 0.5 percent on the day to 97.38 yen, moving away from a two-month low of 96.55 touched on Tuesday, and from Wednesday's session low of 96.83 yen. The dollar broke below its 200-day moving average against the yen for the first time since November on Tuesday, but the break was not sustained.
The euro was slightly lower at $1.3563.
"It might be counterintuitive that the dollar rose on news that a dove is likely to be the next head of the Fed, but the news itself removed some of the uncertainty, and therefore contributed to risk-on sentiment," said Ayako Sera, market economist at Sumitomo Mitsui Trust Bank in Tokyo.
The dollar index erased early losses thanks to the weaker yen, and was up about 0.1 percent at 80.128. But it did not stray far from a 79.627 trough hit last Thursday, a low not seen since early February.
Strategists and market participants were sceptical that the risk-on mood would last long, in light of the continued standoff in Washington.
"I wouldn't expect this rally in risk to be too sustainable given much bigger issues at play including the U.S. government shutdown. The Oct. 17 initial deadline looms large as well," said Sue Trinh, senior currency strategist at RBC in Hong Kong.
Concerns are rising that a resolution will not be reached before that deadline when Congress must decide whether to raise the government's borrowing limit, or the U.S. faces an historic debt default.
The uncertainty is likely to leave investors reluctant to take on big positions, and keep major currencies in tight ranges.
"It seems increasingly likely that the impasse in Washington is going to persist up to or even beyond the Oct. 17 soft deadline for raising the debt ceiling, implying near-term risks to the downside for the USD," analysts at BNP Paribas wrote in a client note.
"We think USD/JPY is particularly vulnerable in light of stretched short yen positioning and the yen's structural tendency to perform well in periods of elevated risk aversion and market stress," they said.
On the other hand, Brown Brothers Harriman strategists told clients "We think risk-reward pays to be long the greenback, with stops below 96.50 yen."
Still, while there is no sense of panic in financial markets yet, signs of unease have started to emerge, such as investors' waning appetite for U.S. Treasury bills.
Normally an uneventful offering, Tuesday's sale of one-month bills met such weak demand that investors sought the highest yields in five years, against a backdrop of concern about the possibility of default.
Traders expect the dollar would underperform safe-haven currencies such as the yen and Swiss franc if a worst-case scenario cannot be averted and the U.S. defaults on its obligations, but emerging market currencies would be hit even harder.
A senior U.S. Treasury official called on Congress to reopen the government and raise the debt ceiling or risk hurting the United States' international reputation as a safe haven and stable financial centre.
The chief economist of the International Monetary Fund also warned that failure to lift the debt ceiling would lead to dramatic cuts in government spending and "probably ... a lot of financial turmoil."
So far, though, there was no sign of a breakthrough in Washington. Obama said he would be willing to negotiate on budget issues only after House Republicans agree to reopen the federal government and raise the debt limit with no conditions.
House Republicans said they would insist on deficit-reduction talks with Obama as a condition for raising the federal debt limit.
Investors will also be keeping an eye on minutes of the Federal Reserve's September meeting, when the central bank caught markets off guard by maintaining its bond-buying stimulus programme. The minutes are due out at 1800 GMT.
The current budget impasse and growing danger of the U.S. economy slipping back into recession appeared to validate the Fed's decision to remain cautious.
But dollar bulls maintain hope that once the budget impasse and default danger passes and the economic recovery is back on track, the U.S. central bank will begin to taper its asset purchases.
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