* Low U.S. inflation dents rate hike expectations
* US dollar falls against euro, hits two-week lows vs yen
* U.S. current account narrows in first quarter
(Adds comment, updates prices)
By Wanfeng Zhou
NEW YORK (Reuters) - The U.S. dollar fell for a second day against major currencies Wednesday after tame U.S. inflation data dampened speculation the Federal Reserve would raise interest rates anytime soon.
A run-up in stock prices and better economic data in recent months had led investors to believe the U.S. recession was coming to an end and that interest rates may need to rise by year end.
But investors pared back such expectations after a Labor Department report on Wednesday showed U.S. consumer prices rose just 0.1 percent month on month in May, and fell over the past 12 months by the most since 1950.
Higher interest rates in the U.S. compared to Europe tend to attract investment flows into the U.S. dollar.
"The latest inflation data has obviously reminded market participants that inflation is still not as much of a worry right now," said Samarjit Shankar, director of global foreign exchange strategy at the Bank of New York Mellon in Boston.
"The market has had to scale back its expectations for a Fed rate hike. That has obviously taken away some element of support for the dollar," he added.
In late New York trading, the euro rose 0.8 percent to $1.3949 on electronic trading platform EBS, hitting a session peak of $1.3986 earlier in the session.
The U.S. dollar fell to roughly two-week lows against the yen to 95.51 and was last at 95.64 yen, down 0.8 percent on the day.
The change in the outlook for U.S. interest rates was a relief to investors worried about a recent surge in U.S. Treasury bond yields which had raised fears that higher rates could clip an economic recovery.
"We're seeing dollar weakness because the idea is that inflation is not pretty evident right now and that is seen as a positive in terms of the growth outlook and risk appetite," said Brian Dolan, chief currency strategist at Forex.com in Bedminster, New Jersey.
The ICE Futures' dollar index, which measures the value of the greenback against a basket of major currencies, dropped 0.6 percent 80.247.
CURRENT ACCOUNT DEFICIT
A brief recovery in the U.S. stock market in afternoon trading Wednesday also improved risk appetite in general and reduced safe-haven demand for the greenback.
Adding to optimism in the currency market was an earlier report showing the U.S. current account deficit narrowed in the first quarter. The current account gap of $101.1 billion was the smallest shortfall since the fourth quarter of 2001.
"The U.S. current account deficit, although higher than expected, continues to narrow rapidly," Vassili Serebriakov, currency strategist at Wells Fargo, wrote in a note.
"This implies that the U.S. will need to borrow less from the rest of the world to finance its trade deficit and is a long-term positive for the greenback in our view."
Concerns over the dollar's role as a global reserve currency also continued to weigh on the market, a day after the leaders of Brazil, Russia, India and China, known as the BRIC group, called for a "more diversified international monetary system."
The presidents of Russia and China on Wednesday agreed to boost the use of their national currencies, the rouble and yuan, in bilateral trade. Russia has recently repeatedly called for less global reliance on the U.S. dollar.
Bank of New York's Shankar said there's already evidence that some central banks have started to reduce the proportion of dollar-denominated holdings in their new currency reserves. "It's going to be a long-term negative for the dollar," he said.
In other currency trading, sterling traded at $1.6406, up 0.1 percent on the day, after Bank of England Governor Mervyn King said there are signs the British economy is starting to stabilize. But he added that it is too early to remove the huge degree of stimulus in the economy. (Additional reporting by Gertrude Chavez-Dreyfuss)