* Dlr pauses from gains, investors reassess U.S. rate view
* Euro slips after German industry output falls
* Sterling firmer on data, lull in political storm
By Naomi Tajitsu
LONDON, June 9 (Reuters) - The dollar paused from gains on Tuesday while investors questioned whether there was a strong enough chance of a U.S. interest rate rise later this year to justify pushing the currency higher.
The euro slipped after a bigger-than-expected fall in German industry output suggested the euro zone's biggest economy is still suffering from slack global demand for its goods.
The dollar pulled back from early losses, but stayed under downward pressure due to a rise in sterling, whose rally on stronger-than-expected UK economic data and signs of greater political stability helped to support the euro against the dollar.
The dollar had climbed after U.S. jobs data late last week stoked the view that U.S. rates may rise from roughly zero at the end of 2009. But its rally had fizzled by Tuesday as a lack of major economic data or events left traders with few reasons to push the dollar higher, analysts said. "The market has not moved significantly towards dollar-positive sentiment, and it's fair to expect that investors are unwilling to take on strong positions (in favour of the U.S. currency)," said Michael Klawitter, senior currency strategist at Dresdner Kleinwort in Frankfurt.
Traders said they were focusing on economic indicators and auctions for U.S. debt later this week to gauge whether a shift towards a dollar-positive trend will take hold.
The euro traded 0.1 percent lower on the day at $1.3883, according to Reuters data, down from the day's high of $1.3963 after figures showing that German industry output fell 1.9 percent in April from the previous month, reversing a positive reading from March.
Still, the euro trimmed some losses made on Monday when Standard & Poor's downgraded its sovereign rating on Ireland.
Some in the market said that the view that Latvia may not have to devalue its currency to deal with extreme economic weakness also provided some support to the euro. Latvian Finance Minister Einars Repse on Tuesday said that a devaluation of the lat was "absolutely out of the question" and had never been discussed.
The U.S. currency was little changed against a basket of currencies at 80.748, but was down from 81.466 hit on Monday for the first time since May 20.
Sterling was up 0.4 percent at $1.6110, recovering from a slide to $1.5803 the previous day, after data suggesting the ailing housing market may be nearing a trough.
Traders in London said the pound was also boosted on relief that political troubles facing UK Prime Minister Gordon Brown appear to have calmed for now, after members of his party offered their support to his leadership on Monday.
Despite its broad losses, the dollar rose 0.4 percent against the yen to 98.05 yen as a 0.4 percent rise in European shares stung the yen, which had gained earlier in the year due to risk aversion.
Dollar losses were limited after Chinese Vice Foreign Minister He Yafei said Beijing, the largest holder of official currency reserves, had no intention of abandoning U.S. dollar assets, saying that no one is talking about "dumping the dollar"
The comments added to the market's view that a sudden diversification by countries holding massive amounts of U.S. Treasuries away from dollar assets is unlikely.
U.S. RATE VIEW
Data last week showed the pace of U.S. job losses slowed sharply in May, sparking talk that the Federal Reserve may raise rates later this year and boosting the dollar.
On Friday, U.S. short-term interest rate futures, which track market expectations for Fed rate policy, had their first meaningful move in months -- bringing forward the possible timing of a Fed rate hike to late 2009 from early 2010.
U.S. two-year Treasury note yields stood at 1.338 percent on Tuesday, after rising above 1.4 percent on Monday for the first time in seven months.
Some analysts argue that a rise in inflation risks is unlikely this year given that the global economy continues to struggle and it may therefore be premature to reward currencies on rate rise expectations.
"Yes, the deterioration in U.S. data has slowed, but to suggest that this automatically extrapolates the view that 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."
Market participants said they were awaiting an auction of three-year U.S. Treasury notes later in the day and auctions of 10-year and 30-year U.S. Treasuries later in the week to get a better picture of rate expectations. (Editing by Ruth Pitchford)