* Nonfarm payrolls increase 204,000 in October
* Expectations grow Fed may start cutting stimulus in December
* Euro falls after shock ECB rate cut, French S&P downgrade
By Wanfeng Zhou
NEW YORK, Nov 8 (Reuters) - The dollar rallied broadly on Friday after a report showed U.S. job growth unexpectedly accelerated in October, boosting expectations the Federal Reserve may start scaling back massive stimulus later this year.
Employers added 204,000 new jobs last month, beating expectations of an increase of 125,000, the Labor Department said. The report suggested the economy was on firm footing and a partial government shutdown had a more limited impact on the economy than initially feared.
A cutback in stimulus by the Fed, at a time when the European Central Bank and Bank of Japan are in easing mode, will boost the dollar’s yield appeal. The dollar has fallen in recent weeks on speculation that the Fed may not start reducing its $85 billion per month bond purchases until next year.
“It’s an impressively strong jobs number in the face of a government shutdown and underlying weakness in the U.S. economy. This number has totally re-written the outlook for the U.S.,” said Richard Franulovich, senior currency strategist at Westpac in New York.
“I have been dismissive of a December taper from the Federal Reserve, and now it looks like a possibility.”
The dollar index, which tracks the greenback versus a basket of six currencies, rose 0.6 percent to 81.308, edging back towards a near two-month high of 81.46 set on Thursday.
The euro fell 0.5 percent to $1.3347, having hit a session low of $1.3316, according to Reuters data, still above a seven-week low of $1.3295 struck on Thursday.
Negative sentiment on the euro grew after the European Central Bank shocked investors by cutting the interest rate on Thursday and Standard & Poor’s downgraded France’s credit rating to AA from AA+.
Money markets and the currency options market are suggesting the euro will grind lower in the near term as it loses its yield advantage over other major currencies.
Citigroup put a sell recommendation, targeting a drop to $1.3050.
“Given the ECB’s view of a prolonged period of low inflation, any further slowing in CPI will raise the threat of negative deposit rates - which will be a big negative for the euro,” said Chris Turner, chief currency strategist at ING.
Against the yen, the dollar rose 0.9 percent to 98.94 yen, having climbed to a session peak of 99.21 yen. On Thursday, the dollar hit a near seven-week high of 99.41 yen.
The dollar was on track for its second straight weekly gain against the euro, with the latter falling about 1 percent. Against the yen, the dollar was headed for a gain of 0.3 percent, also a second week of advance.
Some analysts said the details of the jobs report still suggest worries in the labor market, such as the falling labor force participation rate, which has limited the dollar’s rally.
“The headline is spectacular, but the number everyone is looking at is the change in household employment, which fell 720,000. Another big concern is the labor force participation rate dropping,” said Douglas Borthwick, managing director, Chapdelaine Foreign Exchange in New York.
“That is stopping the dollar from strengthening as much as you would expect on the headline.”
After the jobs data, U.S. short-term interest rate futures suggest traders are expecting a 47 percent chance the Fed will hike rates in April 2015 and a 55 percent chance of a rate hike in June 2015.
On Thursday, the April 2015 fed funds contract suggested a 43 percent chance of a rate hike and the June 2015 contract a 51 percent chance.