* Euro rises above $1.40, dollar buying runs out of steam
* Sterling firmer on data, lull in political storm
* Investors reassess U.S. rate view, growth outlook
* 10 U.S. banks to pay back taxpayer funds (Updates prices, adds comment, changes byline, dateline)
By Steven C. Johnson
NEW YORK, June 9 (Reuters) - The dollar ended a two-day winning streak on Tuesday and fell against major currencies as investors questioned whether the economy had improved enough to justify talk of higher U.S. interest rates by year end.
The euro rose above $1.40 and sterling rose above $1.62 as European and U.S. stocks gained and the U.S. Treasury said 10 of the country's biggest banks could repay a combined $68 billion of taxpayer money received during the height of the credit crisis.
Rising two-year U.S. government bond yields and recent data showing employers cut fewer jobs than expected in May triggered a spike in U.S. short-term rate futures last week, leaving some to predict the Federal Reserve could hike rates in late 2009.
That lifted the dollar in the past two trading sessions, helping it retrace some of its losses suffered in May, but analysts said a U.S. jobless rate that continued to rise would keep the Fed on the sidelines.
"There's a very trivial chance that the United States will see significant inflation in the next 12 months," said Michael Woolfolk, currency strategist at The Bank of New York-Mellon.
"I fully expect the dollar to trend weaker over the next several weeks unless big problems in Europe develop," he said.
The euro wobbled overnight after a sharp slide in German industrial output suggested the biggest euro zone economy is still facing weak global demand for its goods.
But hope that Latvia, one of the most troubled economies in Eastern Europe, may yet avoid devaluing its currency helped the euro, while stronger-than-expected UK housing data and fading fears of a government collapse there lifted sterling.
The euro rose 0.6 percent to $1.3980 after hitting a session peak of $1.4025, and sterling added 1.1 percent to $1.6222 after falling below $1.58 a day ago. Traders said the pound also gained as members of Prime Minister Gordon Brown's Labour party offered him support.
The dollar fell 0.8 percent to 97.66 yen and 1.4 percent to 7.7360 Swedish crowns after Latvia's finance minister said devaluation of the lat was "absolutely out of the question."
Sweden's currency had fallen sharply of late because of Swedish bank exposure to Latvia's economy, which may shrink by as much as 18 percent this year.
Earlier, dollar losses were checked when a government official said China, the largest holder of foreign reserves, had no intention of abandoning U.S. dollar assets, adding no one talks about "dumping the dollar."
But overall, investors remained wary of making big bets in favor of the dollar, especially as they rethought the chances of a Fed rate hike this year. Two-year Treasury yields eased to 1.335 percent on Tuesday after rising above 1.4 percent on Monday for the first time in seven months.
"Yes, the deterioration in U.S. data has slowed, but to suggest .... the Fed is looking to take back some monetary easing before year end is somewhat injudicious," said Jeremy Stretch, strategist at Rabobank in London. "It's safe to say that market is getting ahead of itself."
Investors said they were awaiting an auction of three-year Treasury notes on Tuesday and sales of 10-year and 30-year debt later this week for a better picture of rate expectations.
(Additional reporting by Naomi Tajitsu in London) (Editing by Theodore d'Afflisio)