* Dollar index at 3-1/2 mth low; euro supported before ECB
* Fed's Bernanke expected to confirm policy will stay loose
* Euro targets 2011 high of $1.3862 before test of $1.40
* Sterling hits 13-month high vs dollar, CAD at 3-year high
(Updates prices)
By Jessica Mortimer
LONDON, March 1 (Reuters) - The dollar hit its lowest in three-and-a-half months versus a currency basket on Tuesday on the view U.S. monetary policy will remain loose, as the market awaited testimony by Federal Reserve Chairman Ben Bernanke.
With other central banks looking likely to hike interest rates, analysts said the dollar could extend falls if Bernanke stays cautious about the economy and relatively relaxed about inflation at his semi-annual appearance before the Senate Banking Committee starting at 1500 GMT.
Meanwhile, expectations of higher rates in the euro zone and UK pushed the euro close to its 2011 high against the dollar of $1.3862 and sterling to its highest in more than a year.
The euro was expected to remain supported ahead of a European Central Bank policy meeting on Thursday, where it may signal a willingness to raise rates.
"Interest rate differentials are likely to continue to drive markets, and although Bernanke should acknowledge improvements in the economy he is unlikely to change his stance in the short term," said Richard Falkenhall, currency strategist at SEB in Stockholm.
The dollar index, which tracks its performance against a basket of major currencies, fell to 76.735, its weakest level since early November.
The euro was up 0.3 percent at $1.3837, a shade away from a one-month high of $1.3857 hit on trading platform EBS on Monday, while a break of its February high just above there around $1.3862 would mark its highest since early November.
"Upside in euro/dollar is likely to depend on Bernanke. The first level is the 2011 high, and once this breaks we could see a test of $1.40 but for this to happen we would need (ECB President Jean-Claude) Trichet to be quite hawkish on Thursday," said Roberto Mialich, currency strategist at Unicredit in Milan.
Traders said the single currency could struggle to extend gains without a further catalyst, however, with offers reported around $1.3865-70 and barriers at $1.3900, $1.3950 and $1.4000.
Sterling rallied to a 13-month high against the dollar of $1.6330, supported by firm UK data and market expectations the Bank of England will raise interest rates before the Fed.
The Canadian dollar also hit a three-year high of C$0.9699 per U.S. dollar, helped by high oil prices and broad weakness in the greenback.
YEN, SWISS FRANC DIP
The dollar was up against the Swiss franc and the yen, however, as concern about troubles in North Africa and the Middle East eased in the absence of any significant escalation of tensions while oil prices stayed below last week's highs.
Uncertainties in the region remained, however, and analysts said if heightened tensions resume investors could again buy the Swiss franc and yen, the two currencies which have tended to benefit most when market players have sought safety.
"We have seen some consolidation of the risk aversion story as oil prices have stabilised a bit but there are still risks, and any weakening in the Swiss franc and yen could turn into a buying opportunity," Unicredit's Mialich said.
Versus the yen, the dollar rose 0.4 percent to 82.08 yen, hovering near the middle of its roughly 81 yen to 84 yen range seen over the past month. Traders earlier cited heavy buying of dollar/yen by Japanese exporters.
The dollar also rose 0.1 percent versus the Swiss franc to 0.9296 francs.
The Australian dollar was up 0.1 percent at $1.0194, close to a two-month high of $1.0203 hit in Asian trade which could leave it poised to test the multi-decade high of $1.0257 hit late last year. Earlier, the Reserve Bank of Australia kept interest rates unchanged at 4.75 percent, as expected. (Editing by Stephen Nisbet)