FOREX-Grim jobs data, ECB rate hike talk pummel dollar

(Recasts, updates prices, changes byline)

* Dollar drops as May U.S. jobless rate jumps to 5.5 pct

* Dollar set for worst weekly loss vs euro since late March

* ECB officials toughen interest rate hike talk

By Lucia Mutikani

NEW YORK, June 6 (Reuters) - The dollar fell on Friday as an unexpected surge in the U.S. jobless rate revived fears of a deeper and more prolonged economic downturn, diminishing the prospects of Federal Reserve interest rate hikes by year-end.

At the same time, European Central Bank officials appeared to leave little doubt that euro zone rates were set to rise next month, helping to set up the dollar for its worst weekly loss versus the euro since late March.

Pressure on the embattled U.S. currency was also added by the dramatic jump in oil prices to record highs. There are fears that soaring oil prices could further damage the U.S. economy, while simultaneously fanning inflation.

"The data today revealed that the glass is half empty for the U.S. economy," said Brian Dolan, chief currency strategist at Forex.com in Bedminster, New Jersey.

"The outlook has been wavering between a mild and relatively brief downturn and now we have a shot of economic reality that suggests it's going to be a longer and deeper downturn," he added.

The New York Board of Trade's dollar index, which tracks the dollar's performance versus a basket of currencies, dropped to 72.362 .DXY, the lowest in more than two-weeks.

The euro climbed to a session peak of $1.5773 EUR=, on track to post its best weekly gain versus the dollar since late March. It traded at $1.5759 late Friday, up 1.1 percent on the day.

ECB President Jean-Claude Trichet sparked a euro rally on Thursday when he flagged a July interest rate hike to quell inflation pressures. Trichet's remarks trumped Fed Chairman Ben Bernanke's attempt to talk up the dollar two days earlier.

RATE SPREADS MOVE AGAINST DOLLAR

"Interest rate spreads since the ECB announcement yesterday have moved against the dollar. The basic takeaway from all this is confusion from what the Fed initiated on Tuesday to what the ECB did on Thursday," said Dolan.

"We will have to see another round of verbal action from the United States in order to shore up (dollar) sentiment."