Australia dollar drifts off, NZD underpinned by rate outlook

* Aussie shade lower but well within recent range

* Australia trade deficit smallest in eight months

* NZ dollar supported as market anticipates higher rates

By Wayne Cole and Naomi Tajitsu

SYDNEY/WELLINGTON, Jan 7 (Reuters) - The Australian dollar was stuck in a very snug trading range on Tuesday as caution ahead of major events offshore this week outweighed an improvement in the country's trade deficit.

The Aussie AUD=D4 had drifted off to $0.8937, from New York's $0.8956 late on Monday. That merely reversed modest gains made overnight after disappointing U.S. services data provided a fleeting excuse to sell U.S. dollars.

Dealers reported good support under $0.8935 and $0.8885 but also plenty of offers around the 90 cent mark, which were likely to keep the currency bottled up for now.

Many investors were reluctant to open new positions ahead of central bank meetings in the European Union and the UK, and always-influential figures on U.S. payrolls later in the week.

Domestic data showed Australia's trade deficit narrowed more than expected to A$118 million ($106 million) in November, the smallest shortfall in eight months.

Exports to China were the second highest on record in the month, though more recent data from the Asian giant has hinted at some slowing in growth there. News Search ID:nL3N0KG0ZI

The New Zealand dollar NZD=D4 traded around $0.8250, little changed on the day but not far from its recent three-week peak of $0.8316.

It struck a near six-year high around 86.90 yen NZDJPY=R and an eight-month top versus a currency basket =NZD on Monday as investors continue to pick up the kiwi due to strong New Zealand economic fundamentals and expectations that interest rates could soon rise.

Indeed, swap markets CSSY are pricing in a 44 percent chance that the Reserve Bank of New Zealand would raise rates from a record low 2.5 percent this month. Most analysts, however, are leaning towards a move in March. Href="NewsSearch">NZ/POLL

ANZ currency strategist Sam Tuck said the kiwi would likely rise further in anticipation of the Reserve Bank of New Zealand's tightening cycle. However, its upward momentum could peter out in the second half of the year, should the U.S. dollar begin to appreciate on the back of an improving U.S. economy.

"As long as the U.S. economy keeps growing on current trend, around $0,8500, $0.8600 would be my high for the year," he said. This would be just shy of the 2013 peak of $0.8676.

"If we do get back up to those levels, it will be around the time that the RBNZ starts hiking."

In the near term, the currency faced offers in the mid-$0.8300 region. Technical resistance lay at $0.8314, the 50 percent retracement of its October-November slide, while support lay at $0.8249, its 55-day moving average.

New Zealand government bonds 0#NZTSY= rose slightly, nudging yields a basis point lower across the curve.

Australian government bond futures bounced in line with U.S. Treasuries and softness in global share markets. The three-year bond contract YTTc1 added 2 ticks to 96.940, while the 10-year contract gained 4 ticks to 95.710. ($1 = 1.1159 Australian dollars)

(Editing by Chris Gallagher)

Keywords: MARKETS AUSTRALIA/FOREX