* Dlr reverses earlier gains with Wall St seen higher
* Sterling slides on failed gilt auction, retails sales data
* German corporate sentiment hits lowest level since 1990
(Updates prices and quotes, changes byline)
By Kirsten Donovan
LONDON, March 25 (Reuters) - The dollar reversed earlier gains on Wednesday with Wall Street set to open higher, but moves were capped as investors assessed whether the U.S. plan to remove toxic assets from banks was enough to spur an economic recovery.
Sterling extended early broad losses to hit a session low versus the dollar after data showing that retail sales fell more sharply than expected in March and after a dismal UK gilt auction.
The dollar -- which posted its biggest weekly fall last week against a basket of major currencies since 1985 -- held close to Tuesday's highs hit after Wall Street slid as investors paused to weigh-up the likely success of the U.S. government's latest plans to clean up bank balance sheets and revive the financial system.
European shares remained under pressure, but U.S. stock market futures pointed to a modestly higher open on Wall Street.
"People are asking if the bounce in stocks is over. The Dow closing down yesterday has thrown a lot of people and there's some uncertainty, people are waiting to see what the U.S. does when it comes in," said Lee Ferridge, an FX Strategist at State Street Global Markets.
The euro rose 0.3 percent against the dollar to $1.3503, while the dollar index fell 0.1 percent to 84.029.
Earlier, data showed German corporate sentiment deteriorated to its lowest level since unification in 1990. The Munich-based Ifo economic research institute said its business climate index, based on a monthly poll of around 7,000 firms, fell to 82.1 from 82.6 in February
POUND PUMMELLED
The pound took a pummelling after the Confederation of British Industries distributive trades survey balance fell to -44 in March from -25 in February. Analysts had expected a smaller deterioration to -35.
The failure to achieve a fully covered gilt auction, suggesting reduced demand for sterling assets, also weighed on the currency.
Gilt strategists blamed the auction's failure on market uncertainty created by Bank of England Governor Mervyn King when he said on Tuesday that the BoE could scale back its programme of gilt purchases if they were especially successful in boosting the economy.
"The gilt auction was appalling and at the next BoE meeting they may have to extend the range of eligible maturities (for quantitative easing)," said Christian Lawrence, FX strategist at RBC Capital Markets.
"It has weighed on sterling at the margin but a large part of what we're seeing is a correction of sterling's outperformance over recent sessions, a bit of profit taking."
The pound fell 0.64 percent to $1.4581, while the euro rose almost 1 percent to 92.55 pence.
The yen was supported by Japanese investors repatriating funds from overseas before the end of the financial year on March 31, traders said.
The dollar fell 0.1 percent to 97.64 yen, although the euro was 0.14 percent higher at 131.74 yen.
Frankfurt-based Commerzbank currency strategist Ulrich Leuchtmann said although there were no fundamental reasons to buy the Japanese currency, there were concerns that its sharp falls seen in February had been overdone, he added.
"Levels in dollar/yen just below 100 yen are providing relatively strong resistance and are proving hard to break through, so the yen has been going back and forth at the moment."
In other news on Wednesday, Eurogroup head Jean-Claude Juncker said Europe is not prepared to boost spending beyond those stimulus measures it has already announced, even if pressured to do so by the U.S..
--Additional reporting by Jessica Mortimer