FOREX-Dlr pauses rally; spotlight on US bailout, jobs

* Euro poised for biggest wkly loss vs dlr in its lifetime

* Money market squeeze, dovish ECB help underpin dollar

* U.S. House vote on rescue plan and employment data eyed (Changes dateline, byline, adds quotes, updates prices)

By Veronica Brown

LONDON, Oct 3 (Reuters) - The dollar eased from the previous session's searing rally on Friday, but was poised for its best weekly gain versus the euro in the single currency's lifetime after the European Central Bank opened the door to rate cuts.

Markets were also in cautious mode after another tumultuous week ahead of keenly watched U.S. non-farm payrolls data at 1230 GMT and a U.S. House of Representatives vote on a $700 billion financial industry bailout package later in the day.

Demand for the dollar from banks and financial institutions shut out of frozen money markets have helped propel the greenback up nearly 4 percent versus a basket of major currencies .DXY this week, despite the fact that the United States is the epicentre of the global financial crisis.

"The one place where there is relatively (normal) functioning and... relatively normal liquidity is in the biggest market in the world: the spot fx market ... it's certainly a factor affecting the dollar spot rate," said Derek Halpenny, senior currency economist at BTM-UFJ.

The reality of the international nature of the financial market crisis, highlighted by the rescue of some major European lenders including Fortis (FOR.BR)(FOR.AS) this week, has also hurt the euro.

"The U.S. authorities are extremely committed to solving this crisis...Europe would never be able to some up with such a huge stimulus package as they are talking about in the U.S. and that puts the euro area at a very high risk," Danske Bank senior currency strategist John Hydeskov said.

The deteriorating financial backdrop prompted the ECB, which left rates unchanged at 4.25 percent on Thursday, to open the door for its first rate cut in more than five years with President Jean-Claude Trichet saying inflation risks have eased as financial market turbulence hit the euro zone. [ID:nL2205423]

"Trichet opened up for a rate cut, some would say that it's a bit late, but they (ECB) needed some time to change the mood of the board," Hydeskov said.

By 1055 GMT, the dollar index .DXY, which gauges its performance against a basket of six major currencies, was down 0.3 percent at 80.237 .DXY, but still within easy reach of the one-year peak of 80.794 hit in the previous session.

The euro rose 0.3 percent on the day to $1.3854 EUR=, having plumbed a 13-month trough of around $1.3743 on Thursday. The single currency was on track for its worst weekly percentage loss since its inception in 1999.

Against the yen, the single currency was flat at 145.52 yen EURJPY=, but held above a two-year trough of around 144.56 yen touched earlier in the global session.

The dollar eased 0.3 percent to 105.00 yen JPY=.

BANK SQUEEZE

The squeeze in interbank lending -- which has driven three-month dollar Libor rates USD3MFSR= up a full percentage point in two weeks to more than double the Federal Reserve's 2 percent rate target -- is a major factor behind the dollar's gains, analysts say.

Against that backdrop, a slew of data this week showing the U.S. economy has likely fallen into a full-blown recession has done little to take the wind out of the dollar's rise, even as the Fed is seen likely to cut rates as well this month.

But the key U.S. jobs report, which is expected to show the world's biggest economy shed 100,000 jobs in September with the jobless rate steady at 6.1 percent, may help bring market focus back to fundamentals, giving dollar bulls pause for thought.

"We see risks of a weaker outcome. If delivered, U.S. dollar outperformance may well be checked," said ING strategist Tom Levinson, who is expecting a drop of 150,000 jobs and an unemployment rate of 6.5 percent.

(Additional reporting by Ian Chua in London, editing by Andy Bruce)