* Dollar index down from two-month peak
* Solid U.S. jobs data keeps December tapering view alivefor now
* Diverging Fed/ECB policy path expected to mute euro
NEW YORK, Nov 11 (Reuters) - The dollar paused in itsadvance against the euro on Monday after two days of stronggains, with a further rise seen depending on whether U.S. bondyields keep rising amid an intensifying debate on when theFederal Reserve might scale back its stimulus.
But a U.S. government holiday on Monday kept many investorson the sidelines and volumes low. While the euro managed toretrace some of its recent losses, analysts cautioned againstreading too much into Monday's trading.
"It's a very quiet day with more of a relief bounce" in theeuro, said David Song, Currency Analyst at Daily in New York. "Ithink the euro could be in line for another move lower fromhere."
The euro climbed to $1.3412 on lower-than-usualvolumes, but gains were capped as investors began to sell itfrom around $1.3400 through to $1.3410. The euro hit a two-monthlow of $1.3295 last Thursday after the European Central Bankshocked the market with a surprise cut of its main interest rateto a record low 0.25 percent.
The euro zone currency was last trading up 0.3 percent at$1.3402. Against the Japanese yen, the dollar gained 0.1percent to 99.20 yen.
"The dollar has come off slightly, but the defining factoris the rise in the U.S. yields," said Jeremy Stretch, head ofcurrency strategy at CIBC World Markets in London. "The dollarwill be supported and for the euro any bounce toward $1.34 willbe sold into."
The dollar index dipped 0.2 percent to 81.108, afterhaving set a two-month high at 81.482 after a report on Fridayshowed U.S. employers added 204,000 new jobs last month, wellabove the 125,000 new jobs forecast.
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 of 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 pace with the euro zone facing a prolonged periodof slowing 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 in London.
Just $2.89 billion in euros traded on Monday using ReutersDealing data , making it the lowest-volume day for theeuro 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.
- Europe News