Dollar rises; U.S. payrolls drop smaller than expected
* Euro/dollar rallies briefly, slips after stops triggered
* Dlr index on pace for largest weekly gain in 2 mths
* UK political uncertainties slam sterling (Updates prices, adds comment, changes byline)
NEW YORK, June 5 - The dollar rallied on Friday, on track for its largest weekly gain in nearly two months against a currency basket, after data showed the United States shed fewer jobs than expected, boosting hopes for an economic recovery.
The dollar initially sold off immediately following the jobs report, which showed the U.S. economy shed 345,000 jobs in May, well below the 520,000 expected by economists. In the past, the dollar had fallen in response to data hinting at improvement in the U.S. economy, with investors moving into riskier assets, including higher-yielding currencies.
But the U.S. currency rebounded after initial losses, as investors started to focus on improving U.S. economic fundamentals.
"The first 'knee-jerk' reaction was 'the old', risk-positive is dollar-negative response," said Alan Ruskin, chief international strategist at RBS Global Banking and Markets in Greenwich, Connecticut.
"The second thought was that the U.S. was leading the positive risk response and accordingly should not be penalized. The latter logic works on the basis that a recovery is good news for the dollar's main Achilles heel -- fiscal financing."
In early afternoon trading, the ICE Futures' dollar index, a gauge of the greenback's value against a basket of six currencies, rose to 80.522, up 1.3 percent. Its weekly gain was 1.6 percent, on pace for its largest weekly rise since April 12, according to Reuters data.
The dollar rose to nearly one-month highs at 98.33 yen on electronic trading platform EBS. It last traded at 98.24, up 1.7 percent on the day.
The euro was last trading at $1.3989, down 1.4 percent on the day. It earlier fell to a one-week low on EBS at $1.3970, after a knee-jerk jump to $1.4269 after the data.
"Today seems to be the first day in a while where the dollar is responding positively to positive U.S. news," said said Marc Chandler, senior currency strategist at Brown Brothers Harriman. "That has wrong-footed people."
Sterling was down 1.2 percent against the dollar at $1.5993, according to Reuters data, after hitting a one-week low of $1.5959.
The euro was down 0.4 percent at 87.45 pence, after rising to 88.67 pence, a roughly three-week peak.
British Prime Minister Gordon Brown averted the immediate danger of government collapse on Friday with a cabinet reshuffle that bought the loyalty of key ministers, but the political uncertainty weighed on sterling.
By backing down from replacing finance minister Alistair Darling, Brown appeared to have headed off an open revolt by his Labour party for now. But his authority has been wounded at a time when Britain is in its deepest recession in 60 years and markets and the country are looking for strong government.
Such concerns fed into a market already positioned to take the pound lower after a steep rally in the past few weeks.
The dollar also gained 1.7 percent against the Swiss franc to 1.0860 francs on EBS, the biggest once day advance since May 15.
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