FOREX-Dollar hits 3-1/2 year high vs yen on strong data bets
* Dollar/yen hits highest level since August 2009
* Dollar index also firm before U.S. jobs data
* Euro rises 1 percent on day versus soft yen
LONDON, March 8 (Reuters) - The dollar hit a 3-1/2-year high against the yen and rose versus a basket of currencies on Friday, buoyed by expectations of better U.S. jobs data that would add to signs of recovery in the world's largest economy.
Some market players said positive data would fuel speculation the U.S. Federal Reserve will tone down its ultra-loose monetary policy sooner than previously expected.
The euro was close to flat against the dollar at $1.3103 , holding gains from Thursday when European Central Bank (ECB) President Mario Draghi gave less dovish policy signals than some traders had expected.
Even so, a strong non-farm payrolls reading at 1330 GMT could put it back under pressure against the U.S. currency.
"Given that the U.S. looks in far better shape than Europe, the dollar can benefit," said Paul Robson, FX strategist at RBS.
"People are starting to romance the idea that the Fed will taper its asset purchasing so that's dollar supportive, although we think it will be more about cyclical outperformance (of the U.S. economy) than yields."
Robson said if markets really started to price in an exit from the Fed's asset purchase programme, U.S. Treasury yields would rise sharply. That could prompt more investors to buy the dollar, especially against the yen.
The dollar hit a 3-1/2 year high against the yen, rising 1 percent on the day to 95.80 yen, the highest level since August 2009. It has gained 10 percent against the yen so far this year.
Traders reported a four-week dollar/yen put transaction in the options market, giving the buyer the right to sell the dollar at 100 yen in four weeks' time.
The dollar index rose 0.15 percent to 82.192, near a 6-1/2 month high of 82.604 struck on Wednesday and reflecting market expectation of strong jobs data.
Economists polled by Reuters expected the economy to have added 160,000 jobs in February. The unemployment rate is forecast to stay at 7.9 percent.
"Psychologically, the market is braced for a better number and if it comes in at 170-175,000 then we will see the dollar rise further," said Geoffrey Yu, currency strategist at UBS. "A close-to-consensus number is unlikely to have much of an impact, while a bad number could hurt risk appetite."
Yu said any pullback in the dollar, especially against the yen, could be a good buying opportunity.
The yen seems likely to stay under pressure as investors look past the Bank of Japan's (BOJ) decision to hold policy steady on Thursday to its April meeting, where new officials are expected to take aggressive action to beat deflation.
If the BOJ expands its stimulus programme next month that could open the way for a test of 100 yen, said Ronald Ip, Director of Wealth Solutions Group for HSBC Global Markets.
The euro rose more than 1 percent against the yen to 125.67 yen, its highest level since Feb. 20.
It steadied against the dollar, having climbed about 1 percent a day earlier as those betting against the currency covered short positions after the ECB president gave no indication he would cut interest rates further in the euro zone.
Expectations of future rate cuts remained however, reinforced by comments from International Monetary Fund head Christine Lagarde, who said the ECB should lower rates.
Morgan Stanley analysts said in a note to clients the downward revision of (euro zone) growth forecasts and the below-target inflation forecast continued to provide the ECB with flexibility for future action on interest rates.
They said any rebound in the euro against the dollar was an opportunity to sell for an eventual decline towards $1.27/1.28.