By Vikram Subhedar
LONDON, Jan 27 (Reuters) - The dollar extended its recoveryagainst a basket of other currencies on Friday, while banksdragged European shares slightly lower following underwhelmingresults from Swiss major UBS.
The two-day recovery comes after the dollar suffered a 4percent drop in the three weeks from Jan. 3 reflecting doubtsabout how U.S. President Donald Trump's policies will play outfor the currency, particularly after both Trump and TreasurySecretary-designate Steven Mnuchin hinted at concerns over itsstrength.
The dollar index which measures its strength against abasket of six major currencies rose 0.2 percent to100.54.
Trump suggested overnight he would push ahead with a 20percent border tax on Mexico, spurring a slump on the peso andrefocusing market expectations on his pro-business policieswhich, along with healthy corporate results, helped stocks onWall Street to fresh record highs.
Some U.S. protectionism is seen as dollar-positive as it maybring capital home.
"The (dollar) has experienced a powerful reboundre-establishing post-U.S. election relationships between theperformance of risk assets and U.S. bond yields on the one handand the (dollar) on the other hand," said Morgan Stanley FXstrategists led by Hans Redekker, in a note to clients.
Benchmark German bonds are headed for their worst week sincethe aftermath of November's U.S. election on Friday, as Trump'sfirst week in office fuels expectations of inflation andgrowth-boosting policies in the world's biggest economy.
Investor flows continue to point to a preference forso-called "reflation" trades, according to the latest weeklydata from Bank of America-Merrill Lynch and fund tracker EPFR.
Funds investing in TIPS, which offer protection againstrising inflation, high-yield bonds and Japanese equities,attracted inflows over the past week, the data showed.
"But the re-positioning feels grudging and flows have yet toshow big asset allocation capitulation out of bonds intostocks," Bank of America-Merrill Lynch strategists said.
European stocks were headed for a weekly gain ofabout 1 percent though were slightly lower on Friday as weaknessin the banking shares weighed.
A fall in profits sent UBS shares down more than 3 percentas investors locked in some gains following a strong rally infinancials stocks following the U.S. election. The Europeanbanking index fell 1.2 percent.
In the UK, the FTSE was also slightly lower butoutperformed other regional benchmarks supported by mergeractivity as leading supermarket operator Tesco snappeda smaller wholesaler. Tesco shares surged 10 percent.
In commodity markets, oil prices gave up earlier gains asrising crude output from the United States was seen offsettingefforts by OPEC and other producers to prop up the market bycutting supplies.
Trading was choppy however as volumes were lighter thanaverage with much of Asia closed due to the start of the LunarNew Year holiday.
Brent crude futures, the international benchmark foroil prices, were trading at $55.98 per barrel, down 0.5 percentfrom their last close.
U.S. West Texas Intermediate (WTI) crude futures weredown 0.2 percent at $53.67 a barrel. (Editing by Jeremy Gaunt)