* Euro hits 2-1/2-mth low vs dollar on bank, fiscal worry
* German investor sentiment decline prompts euro selling
* U.S. PPI data beats forecasts, NY Fed data disappoints
* Year-end short covering boosts dollar broadly
(Recasts, updates prices, adds U.S. data, comment, changes byline, dateline)
By Steven C. Johnson
NEW YORK, Dec 15 (Reuters) - The dollar rallied on Tuesday, hitting a 10-week high against the euro on concerns about euro zone banks, and soared against the yen as strong inflation data suggested the Federal Reserve may wind down emergency economic support programs more quickly than expected.
Such a move by the Fed, which concludes a two-day policy meeting on Wednesday, would likely be seen as a prelude to higher interest rates in 2010, rendering the dollar more attractive by raising the return on dollar-denominated assets.
Data on Monday showed U.S. producer prices rose 1.8 percent last month, more than expected. That pushed up U.S. bond yields and came on the heels of improved U.S. employment and consumer sentiment data.
"We've had a string of very good U.S. data releases compared to Europe, and today's data suggests inflation is picking up again, so the whisper out there is that the Fed will hike rates sooner than expected," said Michael Woolfolk, currency strategist at BNY Mellon in New York.
A separate report on New York state manufacturing activity fell unexpectedly, though, suggesting headwinds remain.
The euro fell to $1.4524, according to Reuters data, its lowest level since early October. It was last down 0.7 percent at $1.4545. Losses accelerated after a closely-watched survey revealed German investor sentiment soured in December, suggesting sluggish recovery for the euro zone's biggest economy.
A report saying Austrian monetary authorities had put the country's No. 4 bank on a watchlist also knocked the euro, as did ongoing worries about the weak fiscal positions of some euro zone countries. After having its credit rating cut last week, Greece announced spending cuts Monday aimed at reining in its debt.
"Problems in Greece continue, and the news about the Austrian bank hasn't helped either," said Ian Stannard, currency strategist at BNP Paribas in London.
The dollar also soared 1.1 percent to 89.55 yen and 0.8 percent to 1.0394 Swiss francs, while sterling fell 0.5 percent to $1.6230.
The Fed has said it intends to keep interest rates, now near zero, low for an extended period, but markets are starting to think the Fed could at least signal plans to start winding down emergency liquidity provisions when it meets this week.
Until now, its ultra-low monetary policy has kept the dollar under pressure for most of 2009. Though at a 10-week high against a basket of major currencies on Tuesday, the dollar was more than 5 percent weaker on the year.
Some other central banks, meanwhile, have started raising rates. The Reserve Bank of Australia has led the way in the developed world with three consecutive rate hikes in recent months, bringing borrowing costs to 3.75 percent.
But on Tuesday, RBA minutes helped push the Australian dollar down 1 percent to $0.9072. Analysts said the minutes from the Reserve Bank of Australia's last meeting were not as hawkish as markets had expected, suggesting the bank may pause in its tightening cycle.
(Additional reporting by Naomi Tajitsu in London) (Editing by Theodore d'Afflisio)