* Market players still expecting last-minute deal
* Chance of US credit downgrades seen increasing on political paralysis
* Swiss franc gains sharply, yen hits 4-month high vs dollar
* Euro pares gains after Moody's downgrades Greece
* Knee-jerk 'risk-off' moves hurt Aussie
By Hideyuki Sano
TOKYO, July 25 (Reuters) - The dollar dipped in Asia on Monday as U.S. lawmakers had yet to reach a deal to raise the country's debt ceiling with only a little over a week remaining before the deadline to avert a default.
Most investors still assume that sanity will reign in Washington and a debt deal will be done, but the lack of progress in talks over how to cut the U.S. budget deficit is making market players nervous.
The dollar fell to a four-month low against the yen of 78.12 yen and shed 0.6 percent against the Swiss franc to 0.8132 franc, about a centime away from its record low hit last week. The uncertainty over the U.S. debt crisis also kept growth-linked currencies such as the Australian dollar in check.
"It looks like only short-term players are trading now. Most market players have been and still are expecting negotiations to drag on until the very last minute," said Makoto Noji, a senior strategist at SMBC Nikko Securities.
In Washington, White House officials and Republican leaders scrambled to look for ways to bridge gaps over a range of issues, including whether to raise taxes and cut social programmes to cut the deficit, and also over Republican demands for a short-term debt-limit increase that would force President Barack Obama to request further borrowing authority in early 2012.
The impasse prompted White House Chief of Staff Bill Daley to warn that there would be a "few stressful days" ahead for financial markets, with limited time left before the Aug. 2 deadline to lift the $14.3 trillion U.S. borrowing limit.
The U.S. Treasury says it will run out of money to pay the country's bills after Aug. 2, though some analysts say the Treasury may be able to scrape some money to get by for a week or two -- a scenario that some market players are starting to think cannot be ruled out.
"I suspect they will avoid a default. But credit downgrades seem increasingly likely," said a trader at a Japanese bank.
UGLY DUCKLING CONTEST
Some analysts see room for the dollar to rebound if the U.S. comes up with credible deficit-reduction plan in the long term. But others think sharp spending cuts could backfire by slowing the already fragile U.S. economy further.
"Even if they reach a deal, large spending cuts are likely to hurt growth and undermine the dollar," said Masafumi Yamamoto, chief FX strategist at Barclays in Tokyo, adding that Barclays has just revised down its one-month forecast for the dollar to 75 yen from 80 yen.
The dollar held around 78.40 yen, near a four-month low of 78.12 yen hit earlier in the day. Many traders think it could test a record low of 76.25 yen if the U.S. debt crisis drags on.
The dollar's index against a basket of six major currencies stood at 74.202 , holding above Thursday's six-week low of 73.889.
But having broken its months-old trendline support last week, the risk of breaking that low looks big, which could open the way for a test of its June low of 73.506 and year-to-date low of 72.696.
The euro briefly fell after Moody's downgraded Greece by three notches to Ca from Caa1, though the impact was short-lived as the move was hardly a surprise and as traders were gripped by the U.S. debt saga.
The euro was steady at $1.4365 , and the euro zone's lingering debt issues were seen as brakes on the single currency's move higher.
The sweeping bailout and policy package agreed by euro zone leaders last week has helped stem market panic in the short-run. But analysts say the measures may not be enough to bring the crisis to a swift resolution.
"Things aren't too rosy in Europe either and so it's really a contest to see who's the ugliest duckling at the party between the euro and the U.S. dollar," said BNZ currency strategist Mike Burrowes.
The Australian dollar slipped 0.2 percent to $1.0820 in a
knee-jerk "risk-off" reaction to the U.S. debt problems as share
prices fell across the region. U.S. stock futures fell 1.1
percent
But some analysts said the Australian dollar and other commodity currencies could gain, should a full-fledged reallocation out of the United States gather steam, considering that the euro has its own problems and the yen could be next in the line of debt crises given Japan is the most indebted country in the developed world.
"Australia is expected to have a budget surplus in 2012. Investors may look for currencies with sound fiscal background. I wouldn't be surprised if the Australian dollar rises above $1.1," said SMBC Nikko's Noji. (Additional reporting by Wayne Cole in Sydney; Editing by Chris Gallagher)