(Recasts, updates prices)
NEW YORK, Jan 4 (Reuters) - The dollar dropped on Friday after a December report showing the weakest jobs growth since August 2003 fueled fears of a recession and increased the likelihood of an aggressive rate cut by the Federal Reserve this month.
A gauge of the U.S. services sector that registered growth last month took away some of the employment data's sting for the dollar. But the jobless rate rose to 5 percent, the highest since November 2005, the third key U.S. economic indicator this week that was worse than the most pessimistic forecast.
"The near-term implications of this report are clearly negative," said Nick Bennenbroek, head of currency strategy at Wells Fargo in New York, in a note to clients.
Though Bennenbroek suggests the dollar will be stronger in 2008, in the near-term "a revisit of previous dollar lows against the euro and yen is possible," he said.
The euro <EUR=> traded at $1.4763, up 0.1 percent but below the five-week high of $1.4824 reached in the wake of the U.S. payrolls data.
The dollar was down 0.7 percent against the yen, at 108.46 yen <JPY=>, though it rebounded somewhat from losses incurred after the jobs report. Against the Swiss franc, the dollar fell 0.5 percent to 1.1061 francs <CHF=>.
Sterling rose 0.1 percent to $1.9717 <GBP=>.
The New York Board of Trade's U.S. dollar index .DXY fell 0.1 percent to 75.792, after having touched 75.429 after the jobs data, the lowest since late November.
The dollar index has lost 1.2 percent in the first three trading days of the year, its worst yearly opening since the first three trading days of 2006. The index has fallen for the first three trading days of the year for the last three years.
Interest rate futures reflected a more than two in three chance that the Fed will lower its benchmark interest rate by 50 basis points later this month. Such a cut would bring the fed funds rate to 3.75 percent, below all but two of the 10 most liquid currencies. A 25 basis point cut is believed a certainty.
NO LIFELINE FOR THE DOLLAR
The dollar was whipsawed after data showed the Institute for Supply Management's non-manufacturing index registered growth in December and was higher than expected. That contrasted with the manufacturing survey earlier this week, which reflected contraction.
However, the greenback remained down on the day, with the latest ISM data not enough to turn the tide of sentiment against the dollar.
"The fact that ISM non-manufacturing is above expectations is unlikely to change the outlook for the U.S. dollar," said Meg Browne, senior currency strategist at Brown Brothers Harriman in New York.
The slowing U.S. economy generated 18,000 jobs in December, with private sector employment contracting for the first time since July 2003. For more on the employment data, click on [ID:nN04294153].
In contrast to bets for rate cuts in the United States, the European Central Bank appeared more concerned about rising inflation than easing growth, suggesting that rates will likely be left on hold at 4 percent for some time to come, especially after overnight data showed euro zone inflation well above the ECB's target in December. [ID:nBRM000025].
U.S. manufacturing and housing sector data have reflected profound weakness in recent weeks, causing investors to grow skeptical about global growth prospects with the U.S. economy possibly headed to recession.
As a result, they have diminished the role of risk in their portfolios, particularly carry trades, which involve borrowing in a low-yielding currency such as the yen to buy higher-yielding assets.
As a result of this reappraisal of risk, the dollar has fallen 3.5 percent against the yen this week, the largest weekly decline in almost two months.
The euro is down 3.3 percent this week against the yen, the biggest weekly fall since mid August.
(Additional reporting by Steven C. Johnson) (Reporting by Nick Olivari and Kevin Plumberg. Editing by Richard Satran)