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* U.S. Congress approves deal to avoid "fiscal cliff"
* Other issues such as spending cuts, debt ceilings remain unresolved
* U.S. factories returned to growth in December; jobs data due Friday
By Wanfeng Zhou
NEW YORK, Jan 2 (Reuters) - The dollar fell against higher-yielding currencies such as the Australian dollar on Wednesday after U.S. lawmakers approved a last-minute deal to avert huge tax rises and spending cuts, spurring demand for riskier investments.
But the U.S. currency staged a recovery against the euro in late morning trade as some traders booked profits after driving the common currency to a two-week high just below $1.33.
While the passage of the bill to avoid the "fiscal cliff" removed some near-term uncertainty, it did not end the political showdown on the budget. Battles over the sequester, as the automatic spending cuts are known, and the U.S. debt ceiling will come to a head in February.
"They bought some time," said Eric Viloria, senior currency strategist at FOREX.com in New York. "Negotiations are still going to continue and while that happens, there certainly is a bias for risk off."
Higher-yielding and growth-linked currencies rallied. The Australian dollar rose 0.9 percent to $1.0487 after hitting a two-week high. The New Zealand dollar gained 0.6 percent to $0.8328.
The euro fell 0.2 percent to $1.3181. It had earlier hit a high of $1.3299 on Reuters data, the highest in two weeks and not far from an 8-1/2-month high set on Dec. 19.
The euro has gained nearly 10 percent since late July when the European Central Bank President Mario Draghi said the ECB would do whatever it takes to save the euro. Strategists say the euro could see renewed pressure if concerns about the weak euro zone economy reemerge.
Euro zone factories sank deeper into recession in December, data showed on Wednesday. Markit's Eurozone Manufacturing Purchasing Managers' Index (PMI) fell to 46.1 from November's 46.2. It has been below the 50 mark that divides growth from contraction since August 2011.
"We are somewhat cautious about the euro/dollar near-term outlook as it may struggle to extend its gains above $1.33 with investors potentially looking to take-profits at current levels," said Valentin Marinov, head of European G10 FX strategy at Citi. "The next big move may well be on the downside."
By contrast, data on Wednesday showed U.S. manufacturing ended 2012 on an upswing despite fears about the "fiscal cliff," with factories returning to growth in December after contracting the previous month.
On Friday, the ISM services data and the closely watched U.S. nonfarm payrolls data for December will be released.
"The focus moves away from Washington D.C. and goes back to economic data. The market wants to see supporting data that growth is still intact," said Boris Schlossberg, managing director of FX Strategy at BK Asset Management.
"If we see disappointing numbers over the next couple of days, you'll probably see the risk rally come back down."
The euro rose to 115.99 yen on Reuters data, the strongest since July 2011, and was last up 0.4 percent at 114.89 yen. Option barriers were cited at 116 yen.
The dollar rose 0.5 percent to 87.07 yen, having touched 87.33 yen earlier, the highest since late July 2010.
The yen has also come under pressure in recent weeks on expectations a new Japanese government will push the Bank of Japan into more forceful monetary easing.
Speculators' bets against the yen hit more than five-year peaks in December but have eased in the past two weeks. Some strategists warned of a potential yen rebound after the next BOJ meeting on Jan. 21-22.
"If the BOJ signals less appetite for more aggressive quantitative easing at its meeting in late January, despite continuing political pressure and following the measures announced in December, this could be seen as a disappointment," Citi's Marinov said.
In the options market, one-month dollar/yen implied volatility touched an 8-1/2 month high of 9.2 on Wednesday according to Thomson Reuters data as demand to hedge against further yen weakness gathered pace. It was last at 8.65 vols, some way off the mid-December low of 7.1.