FOREX-Dollar surges after ISM beats forecasts

(Updates prices, changes dateline, previous LONDON, adds byline)

By David McMahon

NEW YORK, Jan 3 (Reuters) - The dollar rallied broadly on Wednesday, hitting two-month highs against the yen, after a survey showed the U.S. factory sector expanded in December, defying predictions for another modest contraction.

The dollar jumped after the Institute for Supply Management said its manufacturing index climbed to 51.4, above the 50 threshold that separates expansion and contraction. The greenback erased losses spurred by an earlier report showing the first contraction in the U.S. private sector job market since April 2003.

"The fact that ISM came back above 50 puts the whole soft-landing, dollar-positive scenario back in play," said Boris Schlossberg, senior currency strategist at Forex Capital Markets in New York.

Led by strong gains against European currencies including sterling, the euro and the Swiss franc, the dollar was set for its biggest rise in around six months against a basket of six major currencies .DXY.

The euro EUR= was trading down 0.7 percent on the day at $1.3180, while sterling tumbled more than one percent to a session low of $1.9500 GBP=. The dollar was up 0.55 percent at 119.42 yen JPY= after reaching as high as 119.52 on electronic trading platform EBS.

Earlier in the session, the dollar had given up some ground after a survey showed employment in the U.S. private sector contracted unexpectedly in December.

The ADP National Employment Report showed private-sector jobs likely declined 40,000 in the month, flying in the face of consensus forecasts for a solid rise in jobs.

The soft report led some traders to speculate that the more closely watched nonfarm payrolls report -- due from the government on Friday -- could also come in softer than expectations.

"It points to a pretty poor payroll number on Friday, so I think we'll see some revisions to the expectations for that number," said Shaun Osborne, senior currency strategist at TD Securities in Toronto.

A weak reading in that payrolls report would likely strengthen the view that the Federal Reserve may start cutting interest rates in coming months to shore up a slowing economy.

However, in the wake of the higher-than-expected ISM reading, the futures market is pricing in only a 12 percent chance of a rate cut by March, down from 18 percent in early trading. For more click on [ID:nN03398946].

(Additional reporting by Steven C. Johnson)