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FOREX-Dollar higher, euro undermined by ECB rate-cut expectations

(Updates with late New York prices)

* Currency speculators increase short bets on euro -CFTC

* U.S. dollar index at 3-1/2-month high

By Daniel Bases

NEW YORK, June 2 (Reuters) - The U.S. dollar rose on Monday, aided by subdued German inflation figures and slower-than-expected manufacturing growth in the euro zone, both of which piled pressure on the European Central Bank to ease monetary policy aggressively this week.

The U.S. dollar index rose 0.40 percent against a basket of currencies from its main trading partners, hitting a 3-1/2-month high.

Attention remains squarely on the ECB's policy meeting on Thursday and the U.S. payrolls report for May on Friday.

"The euro has been trading on the softer side in general as we go into the ECB meeting as there is some level of caution here," said Alan Ruskin, global head of G10 currency strategy at Deutsche Bank in New York.

Currency speculators increased short euro positions to 16,633 contracts from 9,220 last week, according to data for the week ended May 27 released by the Commodity Futures Trading Commission on Friday.

The ECB is preparing policy options for its meeting this week that include cuts in all its interest rates, Reuters reported last month.

The euro was at $1.3596, down 0.26 percent in New York trade, close to Thursday's 3-1/2-month low.

Germany's annual inflation rate rose 0.6 percent, less than the 1.0 percent expected in a Reuters poll and the lowest reading since February 2010. Euro zone inflation data is due out on Tuesday.

"Soft inflation now reinforces the point of view that the ECB will remain dovish and remain ready to ease policy in the future. That's negative for the euro," said Vassili Serebriakov, currency strategist at BNP Paribas in New York.

The euro also fell against sterling, down 0.23 percent to 81.18 pence, with diverging monetary policy outlooks for the ECB and the Bank of England underpinning the pound.

In the United States, the Institute for Supply Management's data showed manufacturing activity expanded in May with a reading of 55.4 versus 54.9 in April, just below the Reuters estimate of 55.5. A reading above 50 indicates expansion.

ISM's initial release incorrectly showed activity slowing. The original report, for which ISM blamed a computer glitch, immediately became suspect because it was so far from forecasts.

The original report pushed U.S. Treasury yields down because it supported loose U.S. monetary policy. The dollar followed suit, but only temporarily, as questions in the market fueled doubt over the report's accuracy. Treasury yields have since rebounded.

Earlier, the final reading of the manufacturing Purchasing Managers' Index for the euro zone disappointed, slipping to a six-month low.

The dollar hit a one-month high against the yen, at 102.48 yen, up 0.66 percent, and pierced the 100-day moving average of 102.37. The euro rose 0.40 percent to 139.28 yen .

(Additional reporting by Anirban Nag in London and; Lisa Twaronite in Tokyo; Editing by James Dalgleish, Peter Galloway, Nick Zieminski and Leslie Adler)