* Pace of U.S. job losses slows, boosts recovery hopes
* Dollar hits highest versus yen since mid-June
* Dollar also gains on euro, reversing recent trend
* Markets pricing in tighter Fed policy by mid-2010 (Updates prices, adds detail)
By Steven C. Johnson
NEW YORK, Aug 7 (Reuters) - The dollar vaulted higher on Friday as data showed the pace of U.S. job losses slowed last month, adding to recent evidence that the health of the world's largest economy is starting to improve.
The U.S. currency rose more than 2 percent against the yen to its best level since June and its biggest daily gain against Japan's currency in two months.
Crucially, it also surged against the euro, bucking a recent trend in which the dollar tended to fall on good news as investors shunned it for higher-yield, higher-risk currencies and assets such as commodities and stocks.
Friday's data showing employers cut 247,000 jobs in July -- far fewer than the 467,000 positions lost in June -- added to a batch of strong data that suggested the U.S. economy will recover before other economies do, eventually leading to higher interest rates and boosting the value of dollar assets.
"This is a sign that the currency markets are weaning themselves from 'the-good-news-is-bad-news for the dollar' syndrome and returning to fundamental measures of economic growth and interest rate cycles," said Joseph Trevisani, chief market analyst at FX Solutions in Saddle River, New Jersey.
The dollar soared 2.1 percent to 97.50 yen, while the euro recorded its worst one-day decline in a month, shedding 1.3 percent to $1.4168. It hit $1.4446 earlier this week, its best level since December.
Sterling fell 0.6 percent to $1.6681, retreating further from a 10-month high above $1.70 reached this week. The greenback rose 1.6 percent to 1.0822 Swiss francs.
EYES ON THE FED
July's data showed the smallest monthly job losses since last August and the first decline in the unemployment rate -- from 9.6 percent to 9.4 percent -- since April 2008.
"We've seen improvement in housing, in manufacturing output and now clearly in the job environment," said Greg Salvaggio, vice president at Tempus Consulting in Washington, D.C.
"You add this up and it will lead to dollar gains as we think the U.S. will emerge more quickly from recession."
Short-covering may have accelerated the dollar gains, analysts said. Commodity Futures Trading Commission data on Friday showed speculators boosted their short dollar position to $15.1 billion in the week to Aug. 4, near a one-year high.
Long-dated interest rate spreads between the United States and euro zone moved in the dollar's favor and fed funds futures were pricing in a benchmark U.S. interest rate, currently near zero, of 1.25 percent by mid-2010, the highest since June.
Bets on a Fed rate hike by year end jumped as high as 46 percent from 34 percent before the jobs data.
Alan Ruskin, chief international strategist at RBS Securities in Greenwich, Connecticut, said that "looks premature" but added that "the idea of selling the USD on strong U.S. data because it is risk positive is being appropriately challenged."
Last month, Fed Chairman Ben Bernanke assured markets that the Fed -- the U.S. central bank -- could exit from its super-loose monetary policy should conditions warrant but he also said he expected rates to remain low well into 2010.
The Fed will have another chance to chime in at a meeting next week, and some strategists said it may not be quite as ready to call an end to the recession as markets appear to be.
"The market's probably running a bit ahead of the Fed," said Adam Boyton, senior currency strategist at Deutsche Bank in New York. "We've had one good GDP report, one manufacturing report and one jobs report, and I don't think that's enough." (Additional reporting by Vivianne Rodrigues; Editing by James Dalgleish)