* Euro firmer on ECB rate hike expectations
* Euro seen benefiting from diversification flows
* Yen steady, focus on Japan's nuclear crisis
By Natsuko Waki
TOKYO, March 29 (Reuters) - The euro rose against the dollar on Tuesday after comments by the head of the European Central Bank the previous day reinforced expectations for higher interest rates, while the yen held steady with the focus on Japan's nuclear crisis.
ECB President Jean-Claude Trichet said on Monday inflation in the euro zone is "durably" above the ECB's target, cementing expectations that the central bank would raise interest rates next month.
His comments also helped relieve pressure on the single currency from the euro zone debt crisis, with concerns rising about Portugal's ability to finance itself.
"Investors are focused on inflation expectations in the euro zone. An April hike may be a done deal, although there's still some uncertainty about what's going to happen beyond that," said Masafumi Yamamoto, chief currency strategist at Barclays Capital.
"A recent rise in oil prices is also raising expectations that oil producers will diversify away from the dollar, which would also benefit the euro."
The euro rose 0.1 percent on the day to $1.4101 , moving away from the previous day's 1-1/2 week low around $1.4020.
Reflecting rising rate hike expectations, key euro-priced interbank lending rates rose to a 22-month high on Monday with the level of excess liquidity in money markets falling.[ID:nLDE72R0W1]
The European single currency is one of the best performing currencies against the dollar this year, having risen 5.4 percent since January. The euro's resistance levels are seen at $1.4220 and $1.4248.
The dollar was slightly weaker at 81.67 yen , having fallen to 81.51 earlier as the discovery of plutonium in soil at the quake-hit Japanese nuclear plant soured risk sentiment.
The low-yielding yen tends to rise in times of risk aversion because Japan's current account surplus puts upward pressure on the yen in the absence of portfolio outflows into risky overseas assets.
A customer dealer for a major Japanese bank in Tokyo reported a significant amount of dollar offers, mainly from Japanese exporters, at and above 82 yen -- the March 18 high hit after coordinated G7 intervention to curb the yen at Japan's request.
He said the dollar is vulnerable to a fall towards 80.80.
Analysts say players would be reluctant to push the dollar below 80 yen on worries about further intervention.
Others also reported talk that Japanese exporters may have over-hedged for the April-June period following production and sales cuts, a factor which could also weigh on the yen.
QE2 ENDGAME
Following hawkish comments by the Federal Reserve last week, interest rate differentials widened in favour of the dollar against the yen.
But that rate support for the dollar waned after another Fed official said on Monday that the U.S. economy still needed support from the central bank's full $600 billion planned bond purchases [ID:nN28221312].
"The likely dip in confidence in the wake of the Japan earthquake and evidence of deepening housing deflation can both serve as reminders that the majority of FOMC members are unlikely to consider current economic performance good enough to meet the hurdle rate for a premature end to QE2," BNP Paribas said in a note to clients.
The dollar index , which tracks the U.S. currency's performance against a basket of major currencies, was slightly higher on the day at 76.150.
The two-year U.S. Treasury yield had risen to a three-week high at 0.785 percent at one stage, up more than 14 basis points in five days, widening its gap over comparable Japanese yields.
Preliminary estimates from Citi's month-end hedge rebalancing model suggested foreign buying of Japanese yen may dominate the March month-end fix.
Citi said Japan's March 11 earthquake and subsequent nuclear crisis had hit local equities hard, leaving foreign investors over-hedged. This means that passive index-following investors may need to buy the yen at the month-end to reduce the value of their hedges.
In other currencies, the signals pointed to net dollar buying against the euro and sterling. (Additional reporting by Masayuki Kitano; Editing by Michael Watson)