* Euro trades slightly below two-year high against dollar

* Dollar index drifts off two-year low touched Friday

By Lisa Twaronite

TOKYO, Oct 28 (Reuters) - The dollar licked its wounds in early Asian trading on Monday, steadying against major counterparts ahead of the U.S. Federal Reserve's policy-setting meeting following a testing week which saw it tumble to two-year lows against the euro.

Economists and market participants widely expect Federal Open Market Committee members to hold steady on purchasing $85 billion of assets next month when they meet on Tuesday and Wednesday. Most expect the central bank to delay tapering its stimulus to at least March next year.

Investors will also keep a wary eye on Chinese short-term rates, after they surged last week to their highest level since the June credit crunch.

"For the coming week, the market will continue to focus on the development in China's money market and the outcome of the U.S. economic data/FOMC rate decision," strategists at Barclays said in a note to clients.

"While the consensus forecast now looks for March 2014 tapering, their policy decision is ultimately data-dependent and incoming U.S. data are worthy of close attention," they added.

The euro was nearly flat at $1.3805, after rising as high as $1.3832 on Friday, its highest since November 2011, according to Reuters data.

The euro remained buoyant despite downbeat German Ifo business sentiment data on Friday, which unexpectedly showed a decline for the first time in six months.

Currency speculators reduced their dollar bets to the lowest level since February in the week ended Oct. 1, according to data from the Commodity Futures Trading Commission released on Friday.

Against a basket of currencies, the dollar was slightly higher at 79.216, but still not far from a near nine-month low of 78.998 touched on Friday.

The dollar added about 0.2 percent against the yen to 97.55 yen, edging away from a more than two-week low of 96.92 yen hit on Friday.

The dollar remained supported against the yen on the view that the yield differential between Japanese government bonds and U.S. Treasuries will persist, as the Fed eventually moves toward tapering its stimulus while the Bank of Japan maintains its ultra-easy stance.

The BOJ is widely expected to maintain its monetary policy stimulus at its meeting on Wednesday and Thursday, to meet its target of two percent inflation in two years.

The BOJ will also release its latest long-term economic forecasts on Thursday. Sources close to the central bank have told Reuters that it is expected to revise up economic growth for the fiscal year beginning in April 2014 to around 1.5 percent from the current 1.3 percent.