* Dollar supported as focus shifts to Fed rate hike
* Yen shows muted response to Japan Q2 contraction
By Hideyuki Sano
TOKYO, Aug 17 (Reuters) - The dollar started the week on a firmer footing on Monday as traders looked to the prospects of a U.S. rate hike next month while the yen was little moved after data showed Japan's economy shrank in the April-June quarter.
The dollar's index against a basket of six major currencies edged up slightly to 96.696 =USD .DXY , extending its recovery from a one-month low hit on Wednesday.
The U.S. currency is slowly recovering from the damage it suffered last week after a surprise decision by the People's Bank of China to devalue the yuan.
Beijing's move had raised concerns that a cheaper yuan would hurt the U.S. economy and make it difficult for the Federal Reserve to raise rates.
"The market is gradually calming down. We still think the yuan has been overvalued and an adjustment in the yuan was necessary," said Bart Wakabayashi, head of forex at State Street Global Markets.
A mixed batch of U.S. data on Friday provided little clarity on whether the Fed will raise interest rates in September.
In July, U.S. producer prices increased for a third straight month, and factory production rose at its strongest pace in eight months, the U.S. government said.
Those figures were somewhat offset by a surprise deterioration in the University of Michigan's index on U.S. consumer sentiment.
With the dollar generally well bid, the euro traded at $1.1097, down slightly from late U.S. levels and off last week's one-month high of $1.1215.
Against the yen, the dollar was little changed at 124.31 yen JPY= , capped by strong resistance in the 125-126 area. Bank of Japan Governor Haruhiko Kuroda said in June that he did not see reasons for the yen to weaken further from those levels.
"The dollar/yen has tested those levels many times and failed to break through... For the moment, I suspect the dollar will go back and forth between 123 and 125," said State Street's Wakabayashi said.
Data from the U.S. financial watchdog showed on Friday that speculators increased their yen short positions in the week to last Tuesday to more than 100,000 contracts, the highest level since eight-month high touched in June.
That suggests many speculators will likely need to buy back the yen in the future.
The Japanese currency was little moved after data showed Japan's GDP contracted an annualised 1.6 percent in the April-June quarter from January-March.
That was slightly better than economists' average forecast of a 1.9 percent fall. (Editing by Shri Navaratnam)