* Dollar index down from two-month peak
* Solid U.S. jobs data keep December taper view alive
* Diverging Fed/ECB policy path expected to mute euro
By Gertrude Chavez-Dreyfuss
NEW YORK, Nov 11 (Reuters) - The dollar fell on Monday aftera two-day rise against the euro as investors locked in gains,but its prospects remained upbeat on expectations the FederalReserve might scale back its stimulus program sooner thanthought following a strong U.S. jobs report.
A U.S. government holiday on Monday kept many investors onthe sidelines and volumes low. While the euro managed to recoupsome of its losses, analysts cautioned against reading too muchinto Monday's trading.
The overall expectation is for the dollar to performfavourably against the euro following a shock interest-rate cutfrom the European Central Bank, and a blockbuster U.S. jobsnumber last week. That robust employment figure has everybodytalking about a December reduction in the Fed's bond buying,which should be positive for the greenback because it means there would be fewer dollars in the financial system.
"Actual or expected tapering will be positive for thedollar. Further delays of tapering will alter the path but notthe ultimate level of the dollar: higher than here," saidStephen Jen, co-founder of London-based investment firm SLJMacro Partners.
The euro rose to $1.3416 on lower-than-usual volumes,but gains were capped as investors began to sell from around$1.3400 through to $1.3410. The euro hit a two-month low of$1.3295 last Thursday after the ECB cut its main interest rateto a record low 0.25 percent.
The euro-zone currency was last trading up 0.3 percent at$1.3414.
"We think this latest bounce in the euro is setting uppotentially good opportunities to enter new shorts against thedollar and sterling, and against the higher-yielding commoditybloc currencies," said Vassili Serebriakov, currency strategist,at BNP Paribas in New York.
Against the yen, the dollar gained 0.1 percent to99.19 yen.
The dollar index slipped 0.3 percent to 81.061 aftersetting a two-month high at 81.482 following Friday's reportshowing U.S. employers added 204,000 jobs in October - wellabove the forecast for an increase of 125,000 jobs.
The data was even more surprising as it came in a month whena budget standoff in Washington forced a 16-day governmentshutdown, suggesting the U.S. economic recovery was on a firmerfooting than previously thought.
As a result, U.S. Treasury yields rose, with the gap betweentwo-year U.S. Treasuries and their Germancounterparts at its widest since mid-July. U.S. bondmarkets were shut on Monday and with yields rising quickly inthe past week, some expect Treasuries to consolidate.
The benchmark 10-year U.S. Treasury note's yield was also near a two-month high as some investors brought forwardto December their expectations for when the Fed will start towithdraw its stimulus.
That underpinned the dollar as rising yields make a currencymore attractive to hold. After the government shutdown, most hadpushed back the Fed's "tapering" expectations to March 2014.
SELL THE EURO
Speculators have cut long euro positions, and this trendcould gather momentum with the euro zone facing a prolongedperiod of slowing inflation. That could see the ECB deployingmore aggressive 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 in London.
Just $2.89 billion in euros traded on Monday, according toReuters Dealing data , making it the lowest-volume dayfor the euro since Oct. 21.
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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