* Dollar index hovers near two-month peak
* Solid U.S. jobs data keeps alive December tapering view for now
* Diverging Fed/ECB policy path expected to mute euro
NEW YORK, Nov 11 (Reuters) - The dollar rally paused on Monday after two days of strong gains, with a further rise seen depending on whether U.S. bond yields keep rising amid intesifying debate on when the Federal Reserve will scale back stimulus.
The euro has struggled as the Fed and the European Central Bank's diverging monetary policy paths prompt investors to sell the currency at higher levels.
But a U.S. government holiday kept many investors on the sidelines on Monday and with volumes low the euro managed some recovery though analysts cautioned against reading too much into Monday's trading.
"It's a very quiet day with more of a relief bounce" in the euro, said David Song, Currency Analyst at DailyFX in New York. "I think the euro could be in line for another move lower from here."
The euro climbed to $1.3406 on lower-than-usual volumes but gains were capped as investors began to sell it at around $1.3400. The euro hit a two-month low of $1.3295 last Thursday after the ECB surprised the market by cutting its main interest rate to a record low 0.25 percent.
"The dollar has come off slightly, but the defining factor is the rise in the U.S. yields," said Jeremy Stretch, head of currency strategy at CIBC World Markets in London. "The dollar will be supported and for the euro any bounce towards $1.34 will be sold into."
The dollar index fell 0.2 percent to 81.148, having set a two-month high of 81.482 on Friday after a report showed U.S. employers added 204,000 new jobs last month, much more than the 125,000 new jobs expected.
The strong data was even more surprising as it came in a month when a budget standoff in Washington forced a 16-day government shutdown, suggesting the U.S. economic recovery was on a firmer footing than previously thought.
As a result U.S. yields rose, with the gap between two-year U.S. Treasuries and their German counterparts at its widest since mid-July. U.S. bond markets were shut 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-month high as some investors brought forward to December their expectations of when the Fed will start to withdraw stimulus. That underpinned the dollar as rising yields make a currency more attractive to hold. After the government shutdown, most had pushed back Fed "tapering" expectations to March 2014.
SELL THE EURO
Speculators have cut long euro positions and this trend could gather pace with the euro zone facing a prolonged period of falling inflation. That could see the ECB deploying more aggressive monetary easing instruments.
"We think investors are caught long near $1.3450, with euro/dollar primed for a move toward $1.32, a level euro zone and U.S. two-year yield differentials would point toward," said Chris Turner, chief currency strategist at ING in London
Although the ECB's rate-setting committee was split about Thursday's decision to cut rates, Executive Board member Benoit Coeure said on Saturday that the bank could trim interest rates further and provide more liquidity.