FOREX-Dollar index hits 8-month low as U.S. gov't shutdown drags on
* Dollar index at 8-month lows as euro extends gains
* Dollar extends losses after weak service sector data
* U.S. jobless claims reflect healing labor market
* ECB and improved data support common currency
NEW YORK, Oct 3 (Reuters) - The U.S. dollar fell for a fifth straight session against a basket of major currencies on Thursday, hitting an eight-month low, as investors fretted about a partial U.S. government shutdown that dragged on for a third day.
While a short-term government closure is expected to have a limited effect on the U.S. economy, the impact will be greater should the impasse continue. A prolonged shutdown could prompt the Federal Reserve to postpone withdrawing monetary stimulus, which will weigh on the dollar in the near term.
President Barack Obama met with Republican and Democratic leaders in Congress late Wednesday to try to break the budget deadlock that has shut down wide swaths of the government, but there was no breakthrough and both sides blamed each other. Obama's healthcare law was at the center of the impasse.
The dollar index, which tracks the greenback against six currencies, hit a trough of 79.740, its lowest since February. It last traded at 79.874, flat on the day. The euro dominates the composition of the index.
The dollar extended losses versus the euro and pared gains versus the yen after U.S. data showed growth in the services sector cooled last month as the pace of new orders dipped and hiring slowed.
The euro hit an eight-month high against the dollar, supported by the weak U.S. data, apparent lack of concern by the European Central Bank about the currency's recent strength and better-than-expected data.
"The euro has become the new safe haven in this environment," said Steven Englander, head of G10 strategy at CitiFX, a division of Citigroup, in New York.
"The situation in Washington has left the dollar vulnerable across the board and its underperformance against other majors like the euro is here to stay for the time being," he said.
The U.S. government standoff comes a few weeks ahead of the next political battle to raise the federal government's borrowing limit. Failure to do this could result in a worst-case scenario of an historic U.S. debt default.
With the government shutdown expected to continue through Friday, the U.S. Labor Department's September nonfarm payrolls report, a key monthly driver of financial markets and a factor in Federal Reserve policy, will be delayed.
The dollar, nevertheless, barely reacted to data pointing to a healing labor market. The number of Americans filing new claims for jobless benefits edged higher last week but remained at pre-recession levels.
In early New York trade, the euro was up 0.1 percent at $1.3594, not far from the session's peak of trading at $1.3623, its highest level since Feb. 4.
Higher-than-expected retail sales, a recovery in the euro zone services sector, along with a jump in Italy's services sector all underpinned the single currency.
Improved political stability after the Italian government won a confidence vote on Wednesday also helped.
On a trade-weighted basis, the euro was trading near highs seen in February before ECB President Mario Draghi flagged concerns about a strong euro and its impact on growth and inflation.
Those comments led to a decline in the exchange rate in subsequent months.
With the euro now back up to February levels, there were expectations that Draghi may talk it down by showing a readiness to offer more long-term loans to banks to keep money market rates from rising. Looser money market conditions and low rates make it less attractive to hold a currency.
However, at his press conference after the monthly rate-setting meeting on Wednesday, Draghi appeared to show little concern, sending the euro to an eight-month high above $1.36.
"President Draghi's appearance is characterised by what he did not say, with little to contain the euro appreciation trend," said Tom Levinson, currency strategist at ING.
"Euro/dollar is primed for a test of its Feb. 1 high at $1.3711, levels the ECB back then was not prepared to accept."
Indeed, one-month euro/dollar risk reversals, which measure the relative demand for options on a currency rising or falling, shows a lesser bias for euro weakness.
Against the yen, the euro was up 0.4 percent to 132.70 yen , while the dollar added 0.3 percent to 97.64 yen , moving away from the previous day's five-week low of 97.12 yen, according to Reuters data.