* Wall St tumbles with Dow, S&P turning negative for July
* Treasuries prices fall, yields rise on inflation fears
* European shares hit 2-week low as worries about U.S. monetary policy hit sentiment
By Angela Moon
NEW YORK, July 31 (Reuters) - Doubts on whether stock markets can ride out a tightening of U.S. monetary policy dominated trade on Thursday, sending major U.S. stock indexes down more than 1 percent, while the dollar edged higher against a basket of major currencies.
The dollar edged higher against a basket of major currencies after U.S. labor market data bolstered expectations for a more hawkish Federal Reserve.
Wall Street tumbled, with the S&P 500 falling more than 1.25 percent during the morning session. The day's broad decline sent the Dow and S&P 500 negative for July.
Weak U.S. data contributed to the bearish tone as claims for jobless benefits rose more than expected in the latest week, and the Chicago Purchasing Managers Index unexpectedly fell in July to its lowest since June 2013.
U.S. Treasuries yields rose as rising labor costs led some investors to prepare for a greater likelihood that the Federal Reserve will increase interest rates next year, while others feared that inflation may be a higher risk if the U.S. central bank is too slow to hike rates.
"Starting with GDP yesterday, it certainly set things off," said Ira Jersey, an interest rate strategist at Credit Suisse in New York.
"In general, you have decent data and if the Fed's behind the curve, you will wind up with inflation running a little bit higher than people thought."
Gross domestic product data released on Wednesday showed a strong rebound in the second quarter from a weak start to the year.
The U.S. dollar edged higher against a basket of major currencies as the weak labor market data bolstered expectations for a more hawkish Fed, though traders are hoping for a strong U.S. nonfarm payrolls report on Friday.
The U.S. dollar index, which measures the dollar against a basket of six major currencies, was last up 0.03 percent at 81.456, down from a 10-1/2 month high of 81.573 touched earlier in the session.
The euro was last down 0.07 percent against the dollar at $1.3387, just above an eight-month trough. The dollar was up 0.07 percent against the Japanese yen at 102.85 yen, but was down 0.02 percent against the Swiss franc at 0.9085 franc.
The benchmark 10-year U.S. Treasury note yield rose to 2.56 percent, from 2.55 percent late on Wednesday.
The Dow Jones industrial average fell 174.39 points, or 1.03 percent, at 16,705.97. The Standard & Poor's 500 Index was down 24.80 points, or 1.26 percent, at 1,945.27. The Nasdaq Composite Index was down 68.39 points, or 1.53 percent, at 4,394.51.
MSCI's All-World Index was down 1.1 percent and European shares fell 1.2 percent.
Euro zone data on Thursday showed inflation slowing to just 0.4 percent, and the pan-European FTSEurofirst 300 index was down 1 percent by midday.
A warning by sports group Adidas about its business in Russia underlined the threats facing European companies. Another worry for some European companies was Argentina's second default in 12 years, following the failure of last-minute efforts toward a deal with holdout creditors.
While debt insurance costs suggested an eventual agreement still seemed possible, the default helped fuel weakness in Spanish and French shares, traders said, with Madrid's main index down 2.4 percent.
(Reporting by Angela Moon; Editing by Dan Grebler)