FOREX-Euro tumbles as inflation data sparks ECB policy action talk

* Euro notches largest one-day percentage loss since April 17

* Euro zone inflation at four-year low, unemployment high

* Market unwinds dollar shorts after Fed announcement

* Dollar buoyed by strong U.S. Midwest business activity data

By Julie Haviv

NEW YORK, Oct (KOSDAQ: 039200.KQ - news) 31 (Reuters) - The euro fell for a fourth straight session against the dollar on Thursday, tumbling to a two-week low as data showing euro zone inflation cooled to its weakest in nearly four years raised speculation the European Central Bank may further ease monetary policy.

The euro's weakness pushed the dollar index, which tracks the greenback against a basket of six major currencies, up for a fifth straight session to a two-week high, as forecasts of ECB action contrasted with expectations of potentially less stimulus from the U.S. Federal Reserve in the months ahead.

Short dollar positions, bets that profit when the dollar drops, taken in recent weeks were unwound after the Fed dropped a phrase in its statement on Wednesday expressing concern about a run-up in borrowing costs and made no direct reference to the partial government shutdown earlier this month.

The Fed's latest outlook was perceived as less dovish than expected, although the central bank maintained its $85 billion per month of bond purchases.

Month-end positioning also weighed on the euro, traders said, which hit a low of $1.3593, its weakest since Oct. 17. It last traded at $1.3598, down 1.0 percent, marking its largest daily percentage loss since April 17.

Euro zone flash annual inflation eased to just 0.7 percent in October. This may raise concerns among euro zone policymakers about deflation risks and damage to the economy from a strong currency. Euro zone unemployment was steady at a record high of 12.2 percent in September.

The soft euro zone data differed from a strong U.S. report that showed business activity in the U.S. Midwest surged past expectations in October as new orders hit their highest level since 2004.

"The strong Midwest business data depicted a resilient U.S. economy and bolstered views the Fed could roll back stimulus soon rather than later," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington D.C.

"The Fed yesterday got the dollar moving in a positive direction after its statement seemingly didn't preclude the chance of a taper before Chairman (Ben) Bernanke leaves in late January," he said.

For the dollar to continue strengthening, however, there needs to be a string of strong U.S. economic data, he said.

One of the data highlights next week will be the October nonfarm payrolls report on Nov. 8.

The euro was earlier weighed down by comments made by ECB Governing Council member Ewald Nowotny, who said the central bank would provide more liquidity when cheap long-term loans it made in late 2011 and early 2012 expire.

"We have had a nasty combination of a lack of inflationary pressures and record unemployment, and the market's interpretation is that the ECB may sit up and take notice," said Jeremy Stretch, head of currency strategy at CIBC.

"The downside risks for euro/dollar look evident and $1.36 is a near-term target."

The dollar index, which is dominated by the euro, reached 80.217, its highest since Oct. 17, pulling further away from a nine-month low of 78.998 hit on Friday. It last traded up 0.5 percent at 80.158.

"In this environment markets are nervous," said Camilla Sutton, chief currency strategist at Scotiabank.

"We would caution dollar bears as some (news) articles are suggesting that a December taper is a real possibility, so there is some added upside risk to the dollar, particularly since the market is now positioned for a first half 2014 taper," she said.

Sutton said month-end rebalancing flows should not play a significant role on Thursday, noting a minimal need for equity portfolio managers to rebalance.

Earlier in the session data showed the number of Americans filing new claims for unemployment benefits declined largely as expected last week as the impact of a California computer glitch worked its way out of the report.

"The market was expecting a relatively dovish outcome from the Fed and that's why we've seen some profit-taking. People had become too bearish on the dollar and too bullish on euro/dollar," said Arne Lohmann Rasmussen, head of foreign exchange research at Danske Bank (Other OTC: DNSKY - news) .

Weaker equity markets helped the safe-haven Japanese currency even as three Bank of Japan board members dissented against the latest semi-annual report, with some citing stronger downside risks to the economy.

The dollar last traded down 0.3 percent to 98.18 yen, according to Reuters data.