Renewed focus on Fed helps dollar pare Wednesday losses

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By Dion Rabouin

NEW YORK (Reuters) - The dollar rose sharply against the euro on Thursday, rebounding from one-month lows reached a day earlier, as markets refocused on an expected interest rate increase from the Federal Reserve.

The euro fell 0.8 percent versus the dollar, turning back a chunk of the previous day's 1.1 percent gain, which came after comments from the European Central Bank's Ewald Nowotny fuelled doubts about how much U.S. and European policy will diverge.

Investors expect the Fed to tighten monetary policy while the ECB eases. But the reduction in the European bank's deposit interest rate was smaller than expected, and Nowotny's comments extended fears the ECB may not take further action.

As uncertainty has grown about the European leg of policy divergence, investors remain convinced the Fed will raise rates at its Dec. 15-16 meeting, which has supported the dollar.

"You are seeing people become more convinced that the Fed is going to move on autopilot," said Karl Schamotta, director of FX strategy and structured products at Cambridge Mercantile Group in Toronto.

"Therefore you are seeing a unidirectional pattern in the market. A lot of the flurry that happened yesterday is percolating out of the market."

Fed fund futures show markets believe there is an 85 percent chance the Fed will raise rates next week. A recent Reuters poll showed that all but one of 18 brokerages that deal directly with the Fed expect a rate increase.

The dollar index , which measures the greenback against six major rivals, rose 0.6 percent to 97.945.

The Australian dollar rose more than 1 percent versus the dollar, boosted by a jobs report showing the strongest Australian employment growth in more than 15 years. That pushed the Aussie sharply up from the previous day's two-week low of $0.7169.

While some questioned the report's strength, it showed the Australian economy moving away from dependence on mining, said Richard Franulovich, senior currency strategist at Westpac Banking Corporation in New York.

"The (jobs) number, along with retail sales, GDP, and a bunch of other numbers, suggests the economy is actually stabilizing," he said. "It's not doing as badly as many people thought because of the commodities trade hit."

(Reporting by Dion Rabouin; Additional reporting by Anirban Nag in London; Editing by David Gregorio)