* Dollar index drops to lowest in almost 5 months

* Sterling at highest in more than 6 mths, above $1.5800

* Dollar falls to 2-month low vs yen

* Fed says it considered buying more securities

By Satomi Noguchi

TOKYO, May 21 (Reuters) - The dollar fell to its lowest in almost five months against a basket of currencies on Thursday, extending a slide from the previous day after the Federal Reserve said it considered buying more securities at its last policy meeting.

The dollar hit a more than six-month low versus the pound and a two-month trough against the yen as an increase in the Fed’s purchases of mortgage agency and government securities would inject more dollars into the global financial system.

“The Fed said exactly what the market wanted to hear so it could sell the dollar, although it’s too early to say whether it’s a decisive trend that will hurt the dollar,” said a portfolio manager at a Japanese asset management firm.

“The dollar’s current drop comes as fears ease about credit and dollar funding, but traders are watching if the focus shifts to a decrease in the value of the dollar expected to come sooner or later,” the manager said.

The dollar had rallied against a basket of currencies as investors rushed to secure cash in dollars during the height of the financial crisis.

In March the dollar index, a gauge of the greenback’s performance against six major currencies, reached its highest since April 2006.

But the index retreated to 80.897 on Thursday, its lowest since early January. That was partly due to improved risk appetite as investors have turned more optimistic on views that the worst of the global financial crisis has passed.

An appetite for risk in other currencies improved after U.S. Treasury Secretary Timothy Geithner said on Wednesday the U.S. financial system was “starting to heal”, crediting an array of emergency government programmes for helping ease a crisis sparked by a surge in mortgage defaults. [ID:nN20501612]

Sterling rose as high as $1.5817, its highest since early November, before retreating to $1.5770 GBP=D4, up 0.2 percent from late New York trade on Wednesday.

The euro was little changed from late U.S. trade at $1.3775 EUR=, staying near Wednesday's high of $1.3831 on trading platform EBS, its highest since early January.

The dollar fell as low as 94.28 yen on trading platform EBS, its lowest since March, before rebounding slightly to 94.50 yen JPY=, down 0.4 percent. The euro fell 0.6 percent to 130.15 yen EURJPY=R.

“Dollar/yen is simply catching up other currency pairs in broad dollar selling. A fall in U.S. Treasury yields the previous day is also encouraging the dollar’s drop against the yen,” said Hideaki Inoue, chief manager of forex trading at Mitsubishi UFJ Trust Bank.

U.S. Treasuries rallied on Wednesday after the release of the minutes from the Fed policy meeting. [ID:nN20492043]

Benchmark 10-year Treasury yields faced downward pressure around 3.19 percent US10YT=RR after falling about 6 basis points the previous day.

Investors will look to the Federal Reserve Bank of Philadelphia’s index of business activity in the U.S. mid-Atlantic region at 1400 GMT and weekly data on claims for jobless benefits at 1230 GMT for more signs that the economy’s deterioration is slowing.

“The dollar and the yen could fall against other currencies and stocks are likely to rally if the Philadelphia Fed’s survey shows some improvement, warming up risk appetite further,” said Masafumi Yamamoto, head of FX strategy Japan at Royal Bank of Scotland.

Economists expect weekly jobless claims to have slightly decreased but remained at a highly recessionary level of 630,000.

A Reuters poll produced a median forecast for a reading of -18 for the Philadelphia Fed’s index in May, improving from the April reading of -24.4. [ECI/US]

The Bank of Japan began a two-day policy board meeting on Thursday. But traders said the event is unlikely to have much impact because the central bank is widely expected to keep its interest rates near zero. [ID:nT231186] (Additional reporting by Rika Otsuka; Editing by Michael Watson)