* U.S. private sector jobs rise; services index up
* Dollar headed for best 1-day rise in 3-1/2 months vs yen
* Portugal borrowing costs soar, Spain issuance on horizon (Updates prices, adds quotes, U.S. data)
By Gertrude Chavez-Dreyfuss
NEW YORK, Jan 5 (Reuters) - The dollar jumped on Wednesday and may continue to extend gains after a batch of upbeat U.S. data affirmed the view that the world's largest economy was on a steady path to recovery.
The greenback was on pace for its biggest one-day gain against the yen in more than three months and more than two weeks against the euro.
The ADP Employer Services report, which showed U.S. private employers added 297,000 jobs in December, further propelled an already rising dollar. The ADP number was the largest increase on record, with data going back to 2000, and far exceeded market expectations for a gain of 100,000.
A separate report showing the U.S. services sector expanded as well in December also lifted the dollar.
"If, in fact, employment is kicking in, then that would set the tone for self-sustained growth, underpin interest rates, and very much underpin the dollar," said Bob Sinche, global head of FX strategy at RBS Global Banking and Markets in Stamford, Connecticut.
Analysts said the private sector employment report bodes well for Friday's U.S. nonfarm payrolls number, which is expected to show gains of 140,000 overall jobs -- and 145,000 private-sector jobs -- last month.
The ADP jobs data followed a series of upbeat economic reports this week suggesting the U.S. recovery seems real and not merely due to short-term government stimulus measures. Earlier this week U.S. factory orders, construction spending and a manufacturing index showed stronger readings as well.
As a result, Sinche said, RBS is "pretty constructive on the dollar this year." He expects the euro to fall into the low $1.20s against the dollar by mid-year, while dollar/yen could rise above 85.
In midday New York trading, the dollar index, which measures the greenback's value against six other major currencies, was up 0.91 percent at 80.167. The dollar surged 1.5 percent against the yen to 83.23 yen.
Traders are now focused on taking out an exotic option barrier at $1.3125 in euro/dollar, a bet that the euro zone single currency will not fall below that level by 10 a.m. EDT (1500 GMT) on Thursday. Consequently, there has been some buying of the euro in efforts to defend that number.
The euro fell 1.1 percent to $1.3157, touching the barrier at $1.3125 with a reportedly $15-$20 million payout. Traders said the seller of the option, who is on the hook for the payout, has bought a substantial amount of euros to try to keep it above $1.3125.
"We're definitely back to a 'buy dollar' mentality and the market is looking to take out key support levels for the euro," said Dean Popplewell, chief currency strategist at OANDA in Toronto.
One of those support levels is the 200-day moving average just below $1.31, which has staunchly supported the euro over the last two weeks and its breach could signal further selling.
The Swiss National Bank stopped accepting Irish government bonds as collateral in its money market operations, a move that also dented sentiment toward the euro.
Portugal, another debt-laden euro zone country, has come under increasing pressure from international debt markets on concerns it may be forced to follow Greece and Ireland and seek a bailout. Demand for Portuguese Treasury bills was solid on Wednesday but yields continued to rise.
Market focus was shifting to Spanish debt issuance for 2011, the first tranche of which comes up for auction next week.
"It's not out of the question that speculators could target Spain in the same way they targeted Ireland," said Stephen Gallo, head of Market Analysis at Schneider Foreign Exchange. (Editing by James Dalgleish)