U.S. dollar drops on bleak private sector jobs data

NEW YORK (Reuters) - The dollar weakened on Wednesday, reversing sharp gains against the euro and yen seen earlier this week, as steep job losses in the private sector rekindled fears of a prolonged U.S. recession.

The report, compiled by ADP Employer Services, showed a decline of 693,000 in U.S. private sector employment for December, which could well prompt some analysts to lower their already weak forecasts for the month.

A Reuters poll shows U.S. non-farm jobs are expected to drop by 500,000 in December.

The dollar pushed back from nearly one-month highs against the euro and five-week peaks versus the yen, with investors locking in gains, including central bank euro buying at lower levels for reserves management purposes as well as interest from funds.

"The ADP report reinforces the view that things could get worse than expected and we're already expecting a long period of weakness," said Meg Browne, a currency strategist, at Brown Brothers Harriman in New York. "That has caused downward pressure on the dollar."

In late New York trading, the euro traded at $1.3618, up 0.8 percent on the day, according to Reuters data. That was down from a session peak of $1.3746, but well off the one-month low touched on Tuesday, according to Reuters data.

The euro, however, remained vulnerable as data showed a rapidly weakening euro zone economy and easing inflation there, which raised the prospects for the European Central Bank to cut rates again next week.

Against the Japanese yen, the dollar fell 1.3 percent to 92.48, after hitting five-week highs the previous day.

The dollar fell 1.2 percent against the Swiss franc to 1.1015 francs, while sterling rose 1.2 percent against the dollar to $1.5101.

Joel Prakken, chairman of Macroeconomic Advisers, said on Wednesday the ADP report suggested that the government's more comprehensive non-farm payrolls data could show a loss of about 670,000 jobs. Macroeconomic Advisers jointly crunches the private sector jobs number with ADP.

Some banks have already revised their forecast for Friday's employment report. Wells Fargo, in a note, said it now expects job losses of at least 600,000, while High Frequency Economics, a research firm in Valhalla, New York, believes employment could decline by 700,000.

Still, analysts said the impact of a potentially dismal number for Friday's jobs data on the dollar could be muted.

Alan Ruskin, chief international strategist at RBS Global Banking and Markets, said recent revisions of ADP data have become a reliable barometer of the upcoming non-farm payrolls report.

"This number should then pre-empt much of the potential dollar-negative, bond-positive, equity/risk negative response that could have occurred on weak non-farm payrolls data this Friday," he noted.

Ruskin thinks it will probably "take dire real economy data to shock a market that has become numb and learned to expect the worst."

Earlier in the session, data showed euro zone producer prices fell sharply in November, logging a record monthly decline on a sharp drop in energy costs.

That came on the heels of data the previous day showing a smaller-than-expected rise in consumer prices, raising expectations that the ECB will be ready to ease monetary policy, not only at its meeting next week, but going forward.

(Reporting by Nick Olivari and Gertrude Chavez-Dreyfuss; editing by Gary Crosse)