* Dollar index rises above 81, highest since late May
* Talk of Fed rate hike sooner than expected supports dlr
* Sterling extends losses, UK political concerns weigh
(Updates prices, adds quotes, changes dateline pvs TOKYO)
By Tamawa Desai
LONDON, June 8 (Reuters) - The dollar rose against a basket of currencies on Monday, extending sharp gains made late last week as U.S. Treasury yields rose to seven-month highs after key jobs data, prompting demand for the U.S. currency.
Smaller-than-expected job losses in the United States in May data released on Friday raised speculation the Federal Reserve may lift interest rates early next year, helping push up Treasury yields.
"The dollar strengthened on the rise in short-term U.S. yields," said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi UFJ.
The U.S. currency was also buoyed as investors focused on improving prospects for the U.S. economy, reversing a trend where the dollar had been sold for higher risk currencies in response to better economic fundamentals.
"If data shows the U.S. economy outperforming others, there may be potential for the dollar to strengthen further in the short term," Hardman said.
Market players covered dollar-short positions, exaggerating gains, as many thought the dollar's recent falls were overdone, traders said.
The dollar index, a gauge of the greenback's value against a basket of six major currencies, rose above 81 for the first time since late May. The dollar index rose 1.6 percent on Friday, its best performance since Dec. 19, Reuters data showed.
At 0800 GMT, the dollar fell 0.1 percent to 98.52 yen, but stayed near a one-month high of 98.90 yen charted on trading platform EBS on Friday.
It slid from that peak as investors took profits, but remained largely supported despite selling from Japanese exporters, dealers said.
The euro slipped 0.7 percent to a session low of $1.3870. Against the yen, the euro fell 0.7 percent to 136.81 yen.
The pace of U.S. job losses slowed sharply last month, the strongest sign to date that the recession is diminishing, even as the unemployment rate hit its highest in nearly 26 years.
Two- and 10-year U.S. Treasuries yields hit highest levels since November in Asia on Monday as Treasuries extended losses.
With currency movements closely following U.S. bond yields, markets will focus on a slew of Treasuries auctions this week. The U.S. government is scheduled to sell $65 billion in debt including 10-year and 30-year securities.
Meanwhile, sterling fell 0.8 percent to $1.5837 on political uncertainties in the UK.
Britain's Prime Minister Gordon Brown may face a renewed challenge to his leadership after support for the ruling Labour Party plunged to its lowest level in a century in European elections. (Editing by Mike Peacock)