* Investors reluctant to trade actively before FOMC
* Dollar hurt after S&P's broad downgrade on U.S. banks
* Yen-selling flows from Japan investment trusts eyed
By Satomi Noguchi
TOKYO, June 18 (Reuters) - The dollar was steady against the euro on Thursday, hovering near lows struck the previous day after tame U.S. inflation data further dampened speculation the Federal Reserve would raise interest rates by year end.
Earlier this month, the market had fully priced in an increase in U.S. interest rates by the end of the year after improving economic data, helping push the dollar up broadly and to a one-month high versus the euro earlier this week.
But data showing a slower pace of increases in U.S. producer prices, a drop in industrial output and, on Wednesday, only a slight rise in consumer prices in May, has reduced concerns of potential inflationary pressures and calmed rate expectations.
Investors were reluctant to trade actively before hearing the Fed's stance on rate moves and bond buying at its two-day meeting next week after a spike in long-term yields this month.
The outcome of the Fed meeting, which starts on Tuesday, and the ensuing reaction in U.S. long-term yields are seen as key to the near-term direction of the dollar, analysts said.
"The Fed probably has to mention the recovery in the economy, but that in turn would make it tough not to push U.S. long-term yields higher," said Etsuko Yamashita, chief economist at Sumitomo Mitsui Bank.
"The key to the Fed's statement this time is probably how the central bank will touch on wording linked to interest rate expectations. The dollar is likely to fall if gaps in U.S. yields and overseas yields shrink," Yamashita said.
The euro held steady from late New York trade on Wednesday at $1.3933, drifting near the previous day's high of $1.3986 on trading platform EBS and above a one-month low of $1.3748 touched on Tuesday.
The dollar fell versus most other major currencies on Wednesday after the unexpectedly small rise in U.S. inflation and on a debt ratings downgrade for U.S. banks by Standard & Poor's.
But the ratings agency also said the United States' top AAA credit rating is unlikely to come under pressure in the near term.
The euro was flat at 133.42 yen after choppy trade above a three-week low of 132.37 yen hit the previous day.
The dollar was also little changed, at 95.76 yen, off Wednesday's low of 95.51 yen, its lowest in two weeks.
The yen had slipped broadly in early trade as short-term speculators were cautious about yen-selling from Japanese retail investors, traders said.
Data showed that a Japanese investment trust investing in Chinese stocks launched this week had gathered its maximum amount of funds, prompting short-term speculators to quickly reverse their yen-long positions against the dollar and other higher-yielding currencies on Wednesday's trade, traders said.
Yen crosses with higher yielders were also quiet, with only the New Zealand dollar slightly down at 60.36 yen.
Higher yielding currencies such as the Australian dollar have come off multi-month peaks against the dollar and yen this month as stock markets have seen a correction to their strong rallies of the previous three months.
The corrections have come as investors have become nervous that the rally in riskier assets has got ahead of economic reality, with data still showing conditions are getting less bad, rather than rebounding.
"The overall sense seems to be that we're still going to see a bit more capitulation in some of the risk currencies such as the Aussie, kiwi and Canada," said Mitul Kotecha, global head of FX strategy at Calyon in Hong Kong.
"There doesn't seem to be huge momentum behind that move at the moment." (Additional reporting by Charlotte Cooper; Editing by Joseph Radford)