FOREX -Dollar pauses after strong gains, euro's gains capped


* Dollar index hovers near two-month peak

* Solid U.S. jobs data keeps alive December tapering view

* Diverging Fed/ECB policy path expected to peg back euro

By Anirban Nag

LONDON, Nov 11 (Reuters) - The dollar paused on Monday aftertwo days of hefty gains, with a further rise seen dependent onwhether U.S. bond yields keep rising as debate intensifies onwhen the Federal Reserve will scale back stimulus.

The euro struggled to make headway as the Fed and theEuropean Central Bank's diverging monetary policy paths promptedinvestors to sell the currency at higher levels.

The euro climbed to $1.3390 on lower-than-usualvolumes but gains were capped as most investors were selling itat around $1.3400. The euro hit a two-month low of $1.3295 lastThursday after the ECB surprised the market by cutting its maininterest rate to a record low 0.25 percent.

"The dollar has come off slightly, but the defining factor isthe rise in the U.S. yields," said Jeremy Stretch, head ofcurrency strategy at CIBC World Markets. "The dollar will besupported and for the euro any bounce towards $1.34 will be soldinto."

The dollar index fell 0.2 percent to 81.139, havingset a two-month high of 81.482 on Friday after a report showedU.S. employers added 204,000 new jobs last month. That handilybeat forecasts for 125,000 jobs.

The strong data was even more surprising as it came in amonth when a budget standoff in Washington forced a 16-daygovernment shutdown, suggesting the U.S. economic recovery wason a firmer footing than previously thought.

As a result U.S. yields rose, with the gap between two-yearU.S. Treasuries and their German counterparts at its highest since mid-July. U.S. bond markets wereshut on Monday, and with yields rising quickly in the past week,some expected Treasuries to consolidate.

The 10-year U.S. yield was also near a two-monthhigh as some investors brought forward expectations of when theFed will start to withdraw stimulus to December. Thatunderpinned the dollar as rising yields make a currency moreattractive to hold. After the government shutdown, most hadpushed back Fed "tapering" expectations to March 2014.


Speculators have cut long euro positions and this trendcould gather pace with the euro zone facing a prolonged periodof falling inflation. That could see the ECB deploying moreaggressive monetary easing instruments.

"We think investors are caught long near $1.3450, witheuro/dollar primed for a move toward $1.32, a level euro zoneand U.S. two-year yield differentials would point toward," saidChris Turner, chief currency strategist at ING.

Although the ECB's rate-setting committee was split aboutThursday's decision to cut rates, Executive Board member BenoitCoeure said on Saturday that the bank could trim interest ratesfurther and provide more liquidity.

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