* Dollar index recoils from 7-month highs, uptrend seen intact
* Sterling jumps as market covers large short positions
* Aussie dollar basks in jobs data afterglow
By Ian Chua
SYDNEY, March 15 (Reuters) - The rally in the U.S. dollar took a breather on Friday as sterling enjoyed a short squeeze, while the Australian dollar made the most of a barnstorming employment report at home.
The dollar index stood at 82.544, having retreated from a seven-month peak of 83.166. Still, it is up nearly 5 percent from its Feb. 1 trough of 78.918.
The pullback came as the euro bounced to $1.3010 from a three-month trough of $1.2911, partly cheered by solid demand for Spanish long-term bonds at an auction.
Against the yen, the dollar was little changed around 96.10 , continuing to consolidate since scaling a 3-1/2 year peak of 96.71 on Tuesday.
Analysts said the pause in the U.S. dollar rally was just that and suspected the greenback could continue to gain ground, particularly against the yen, sterling and euro as the U.S. economy outperforms.
Data showing a fall in the number of Americans filling new claims for employment benefits was the latest in a string of data painting a brighter outlook for the world's biggest economy.
If continued, this is likely to fuel market speculation of when the Federal Reserve will start to slow its asset buying and give dollar bulls a reason to get really excited.
"The exit debate will heat up in the second half of the year," said Sebastien Galy, a strategist at Societe Generale.
"The U.S. economic outperformance and the fears of a not-too-distant Fed exit imply that the dollar is no longer a funding currency of choice in the carry trade."
While the dollar showed further upside potential, the show stealer overnight was definitely sterling and the Australian dollar, both of which made solid gains across the board.
In fact, the pound posted its biggest one-day rise in over seven months as investors scrambled to cover short positions.
It was unclear what sparked the move, but traders reported sovereign buying and pointed to a media report about Qatar planning to invest billions of pounds into key infrastructure projects in Britain.
The move in sterling gathered momentum as buy-stops were tripped, driving the currency up more than 1 percent to $1.5120 , well off a 33-month trough of $1.4832 set earlier in the week. It was last at $1.5084.
Bank of England Governor Mervyn King said the bank was not seeking a further depreciation in sterling and that the currency was now properly valued.
Investors also sought the Australian dollar after a closely watched report on Thursday showed the economy generated 71,500 jobs in February, the biggest increase in over a decade and blowing away even the most optimistic forecast.
Markets quickly moved to price out chances of another interest rate cut and pushed the Aussie dollar sharply higher. The Aussie was at $1.0374, having climbed about 0.8 percent on Thursday, its second best performance this year.
Against the yen, the Aussie stopped just short of hitting 100. It was last at 99.65.
Reserve Bank of Australia Assistant Governor Christopher Kent, however, warned the jobs report could have overstated the true strength of the labour market, noting the outcome might have partly been due to statistical noise.
There is little in the way of major data in Asia on Friday, leaving the focus on inflation figures in the euro zone and the United States.
In Japan, the upper house of parliament is due to vote on the government's nominees for the next Bank of Japan governor and two deputy governors. All three were approved by the lower house on Thursday and are likely to be passed by the upper house as well.
Approval in both houses of parliament is necessary for the nominees to take control of the central bank after its current leadership steps down on March 19.
The new leaders are expected to deliver aggressive easing policies to spur Japan's economy and tackle deflation once and for all.