* Euro jumps to highest in 8 months against dollar
* U.S. quantitative easing worries weaken the dollar
* USD erases earlier gains vs yen triggered by BoJ moves (Updates prices, adds quote)
By Gertrude Chavez-Dreyfuss
NEW YORK, Oct 5 (Reuters) - The U.S. dollar dropped to an eight-month low against the euro on Tuesday as a surprise easing by the Bank of Japan rekindled risk appetite and prompted buying of currencies and assets with higher returns.
In volatile trading, the yen strengthened despite a cut in the BoJ's overnight rate target to 0-0.1 percent from 0.1 percent, pushing the dollar near levels that triggered the Bank of Japan's Sept. 15 intervention to weaken the yen.
The BoJ also said it would create a pool of funds to buy assets in the face of evidence a stronger yen was hurting Japan's economy. For details see [ID:nTOE69305D].
"The BoJ took further steps to provide stimulus to the economy and that has given a boost to risk appetite. As a result, we have seen the dollar come off a lot against the euro," said Eric Viloria, senior currency strategist at Forex.com in New York.
Japan's action also spurred a rally in U.S. stocks, commodities and other high-yielding currencies such as the Australian and New Zealand dollars.
Further boosting risk appetite was a report which showed the U.S. services sector expanded more than expected in September. [ID:nN05177294]
In late afternoon trading, the euro was up 1.1 percent at $1.3839, off a session high of $1.3860 EUR=EBS, the highest since Feb. 4, according to electronic trading platform EBS. Investors reportedly took out stops above $1.3850.
Traders also cited Asian central bank buying of euros against the dollar earlier in the session, while a U.S. bank was also seen buying, driving it up sharply from well below $1.3700. Asian central banks have been diversifying currency reserves away from the dollar, particularly toward the euro.
Analysts said the next big level in euro/dollar is around $1.3897, the 61.8 percent Fibonacci retracement of the move from the November 2009 peak and the June 2010 low. After that, the focus is $1.40, a key psychological level where most investors tend to take profit.
NEAR-TERM EURO PULLBACK IMMINENT
Some analysts warned of a pullback in the euro, having tracked an uptrend since the low of $1.2642 hit on Sept. 10.
"That rally has taken the euro over 1,200 pips from the Sept. 10 low we saw," said Greg Michalowski, chief currency analyst at online forex broker FXDD in Phoenix, Arizona.
"Historically, any range of gains between 1,200-1,300 pips is usually achieved over a month's time. So we may be getting toward the end in the euro rally."
Against the yen, the dollar was down 0.2 percent at 83.20 yen JPY=, reversing a climb to a session high of 83.99 yen on EBS after the BoJ decision. The EBS low was 82.96 yen JPY=EBS.
Analysts said the BoJ's moves were not sufficient to halt the downward trend in dollar/yen, with the U.S. currency pressured by falling U.S. bond yields and expectations the Federal Reserve will implement fresh quantitative easing.
Still some analysts suggested the market may be setting itself up for a disappointment if it continues to expect the yen to strengthen.
"The market is kind of dismissing the BoJ's announcement overnight by buying the yen against the dollar," said Richard Franulovich, senior currency strategist at Westpac in New York. "But I think they're missing the message, which is there is more quantitative easing to come. The yen as a result is going to be hit hard on all the crosses."
The yen fell against other currencies, with the euro EURJPY=EBS up nearly 1 percent at 115.10 yen.
The euro's sharp gains pushed the dollar index to its weakest since January at 77.698 .DXY, while the dollar hit a 2-1/2-year low versus the Swiss franc CHF= at 0.9645 francs.
Talk of the United States adopting more quantitative easing grew after Fed Chairman Ben Bernanke said Monday more Fed asset purchases could further ease financial conditions. [ID:nN04133934]
Analysts said the fact the European Central Bank has not hinted at policy easing measures was seen as positive for the euro, which shrugged off a Moody's warning that the agency might cut Ireland's debt ratings. [ID:nLDE6940AV] (Additional reporting by Nick Olivari; Editing by James Dalgleish)