* U.S. December payrolls unexpectedly decline 85,000
* Optimism on U.S. economy diminishes after jobs data
* Euro/dollar best day since Nov; dlr/yen off 4-month high (Updates prices, adds comment, detail)
By Wanfeng Zhou
NEW YORK, Jan 8 (Reuters) - The dollar suffered its biggest loss against a basket of six currencies in a month and a half on Friday after an unexpected drop in U.S. nonfarm payrolls dented expectations interest rates will rise any time soon.
The greenback also dropped from a four-month high versus the yen, while the euro was on track for its biggest one-day rise against the U.S. currency since late November.
In the last few trading sessions, the dollar had rallied on optimism about the jobs report, with some analysts expecting a return to job growth for the first time in two years. Analysts polled by Reuters had expected no job cuts for December.
But data on Friday showed U.S. employers cut 85,000 jobs last month. November payrolls, however, were revised to show the economy actually added 4,000 jobs rather than losing 11,000 as previously reported. See [ID:nN0747110].
"It was undoubtedly a disappointing number," said Samarjit Shankar, managing director of global FX strategy at BNY Mellon in Boston. "It's put a dent on rate hike expectations ... and is a bit of a setback for investors who were looking for a relatively stable and smooth economic recovery.
"The U.S. still has a weak labor market, and until that gets turned around, you are not going to have a sustainable recovery," he added.
In late trading, the euro <EUR=> traded at $1.4416, up 0.7 percent on the day, the biggest percentage rise since Nov. 25. It had jumped to a high of $1.4439, according to Reuters data.
Marc Chandler, global head of currency strategy at Brown Brothers Harriman in New York, pointed out that the euro has not risen above Thursday's high of $1.4446, which attests to the dollar's resilience.
"(Thursday's high) is an important level that needs to be taken out to boost confidence that a low is in place."
The ICE Futures U.S. dollar index, which tracks the greenback versus a basket of six major currencies <.DXY>, fell 0.6 percent to 77.454.
Interest rate futures traders have reduced expectations the Fed will raise benchmark short-term rates in the first half of the year. They are now pricing a 22 percent chance of a Fed hike by mid-2010, compared with 40 percent before the release of the jobs data. [ID:nN08237912]
In minutes of the Fed's December monetary policy meeting, some Fed officials said persistently high unemployment might make it desirable at some point to expand or extend asset purchases. [ID:nWEQ003714]
But some analysts said the jobs data does not minimize the fact that the U.S. economy has shown improvement, and the dollar's weakness may be short-lived.
"All together this report will probably work against the more optimistic expectations on the U.S. economy," said Vassili Serebriakov, senior currency strategist at Wells Fargo in New York.
"It is negative for the dollar, and we are seeing it getting weaker. But we don't expect to see a complete reversal in the dollar gains from last month based solely on this report. We need more data points," he said.
Against the yen, the dollar fell 0.7 percent to 92.67 yen <JPY=>, coming off a session peak of 93.76, the highest since Aug. 28, according to Reuters data.
News earlier in the session that Japan's new finance minister has backed off his call for a weaker yen following a rebuke from the prime minister helped the Japanese currency recover some ground. [ID:nTOE60701F]
That did not change, however, the market's bias to sell the yen. (Additional reporting by Gertrude Chavez-Dreyfuss and Vivianne Rodrigues; Editing by James Dalgleish)