FOREX-Dollar gains, Eastern Europe woes weigh on euro

* Dollar rises to 2-1/2 month high versus euro

* Moody's, S&P warn of deterioration in eastern Europe

* Dollar Index nears 3-month high on safe-haven flows (Recasts, adds comments, updates prices)

NEW YORK, Feb 17 - The dollar gained broadly, rising to its highest in more than two months against the euro on Tuesday after warnings from two ratings agencies fueled fears a sharp downturn in Eastern Europe would further pressure the euro zone banking sector.

The euro tumbled as concerns grew that a deep and prolonged recession in Eastern Europe would hit western European banks, which have significant exposure to the region.

Standard & Poor's said on Tuesday it may review ratings on banks in emerging Europe as the credit crisis has limited western European banks' ability to supply funding to their subsidiary banks in the region.

The news followed a similar announcement from Moody's Investors Service that the recession in emerging Europe was likely to be more severe than elsewhere and would put ratings of local banks and their Western parents under pressure.

"The credit market dysfunction that has certainly hurt the U.S. economy is...a serious risk for Europe as well. That's pretty negative for the European economic outlook and certainly implies that the (European Central Bank) has more work to do," said Robert Blake, senior currency strategist at State Street Global Markets in Boston.

"It's a pretty significant story that's not going away and may only get worse. That's certainly a negative for the euro," he added.

Gloom about the global economy and steep declines in Wall Street stocks, meanwhile, fed broad dollar gains as investors sought the relative safety of the greenback.

Adding to gains in the dollar was a report from the Treasury Department showing net long-term capital flows, a key gauge of foreign investor appetite, showed an inflow of $34.8 billion in December. That compared with revised outflows of $25.6 billion the previous month.

The data eased worries that foreign investors, especially China, are backing away from U.S. assets.

"Despite China's own problems and the deteriorating balance sheet in the U.S., the Asian giant continues to fund the U.S. deficit," said Kathy Lien, director of currency research at GFT in New York.

In midday trading in New York, the euro was down 1.6 percent against the dollar at $1.2570, according to Reuters data. It had earlier fallen to $1.2565, its weakest since Dec. 4.

The ICE futures' U.S. dollar index, which measures the greenback's value against six major currencies, rose 1.5 percent to 87.798 after hitting 87.821, its highest since November.

Investors remained averse to risk, pushing the yen higher against most currencies due to its safe-haven status. The currency, however, struggled versus the dollar after data showed Japan's economy shrank in the fourth quarter at the fastest pace in 35 years and the finance minister resigned.

The euro fell 0.8 percent to 116.22 yen, while the dollar edged up 0.8 percent to 92.42 yen, having earlier risen to a one-month peak at 92.75.

"Investors are focusing on bad news from Eastern Europe and on the slide in Japan's GDP," said Matthew Strauss, senior currency strategist at RBC Capital Markets in Toronto.

"That will keep risk aversion high. There's nothing out there that suggest a change in sentiment."