* Dollar index retreats from two-week highs set last week
* Euro gains despite indecisive Spanish election results
* Azerbaijan's manat plunges after currency support ends (Updates market action)
By Richard Leong
NEW YORK, Dec 21 (Reuters) - The dollar weakened against a basket of currencies in thin trading on Monday as the euro strengthened in the wake of an inconclusive Spanish election result that may increase unease over the country financial stability.
With the historic U.S. rate liftoff in the rear view mirror, traders focused their attention on slumping commodities prices on the global economy and central bank policies with oil hitting fresh 11-year lows. O/R
The dollar index .DXY has retreated from two-week highs following the U.S. Federal Reserve's first rate increase in nearly a decade last Wednesday.
"The U.S. rate hike went off extremely well. It should be dollar positive over time," said Alan Ruskin, global head of G10 currency strategy at Deutsche Bank (DE:DBKGn) in New York.
Still the greenback lost ground broadly at a start of an abbreviated trading week when U.S. and most European markets will close on Friday for Christmas.
The euro rose even after no party in Spain won a clear mandate to govern this weekend, raising concerns about economic reforms in the euro zone's fourth biggest economy. urn:newsml:reuters.com:*:nL8N14A273
Traders attributed the rise in the euro to short covering of existing bearish bets in the run up to the election, rather than the election being good for the single currency.
The euro was up 0.5 percent at $1.0920 EUR= and was 0.3 percent higher at 132.19 yen EURJPY= .
The yen dipped 0.1 percent against the greenback at 121.03 yen. JPY=
The dollar index .DXY was down 0.3 percent at 98.396 after hitting a two-week high of 99.294 last Thursday. Its decline was limited by a rebound in U.S. stock prices and a fade in a decline in U.S. yields in afternoon trading. .N US/
Given the broad consensus in the market that the dollar will rise in the first quarter, the now minimal scale of those bets leaves room for some of the big money investors who have cashed up this month to buy back in.
"I find it hard to imagine big moves in the dollar against the euro or yen by the end of the year, but there is certainly some potential for it to gain against sterling or some of the commodity-linked currencies," said Simon Derrick, chief currency strategist at Bank of New York Mellon (N:BK) in London.
Among commodity-linked currencies, the Australian dollar was up 0.1 percent at $0.7192 AUD=D4 , while the New Zealand dollar NZD=D4 was nearly 0.7 percent higher at $0.6777.
On the other hand, Azerbaijan abandoned support of its currency resulting in a 32 percent drop versus the greenback after spending half of its currency reserves to prop up the manat due to the drop in oil prices. urn:newsml:reuters.com:*:nL8N14A0BU