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The euro slipped against the dollar after two days of gains, supported overnight by talk that the European Central Bank of was buying bonds of peripheral countries such as Ireland and Portugal, even though no new policy was formally announced.

With the euro little changed this week at $1.3211 and holding above its 200-day moving average despite the euro zone fiscal crisis, investors ahead of the U.S. payrolls report put cash to work in stock markets, lifting Japan's Nikkei share average to its highest since May.

"It is clear that the labor situation is improving and with consumption demand -- the final demand that drives all else -- strengthening by the day, hiring should continue to improve," economists at DBS Group in Singapore said in a note.

The Nikkei rose 0.6 percent .N225, driven higher mainly on buying of technology stocks.

For a second day, the technology sector also outperformed in the MSCI index of Asia Pacific stocks outside Japan .MIAPJ0000PUS. The index was up 0.5 percent and extended a 3.5 percent gain in the week, on track to exceed weekly returns of Japanese stocks for the first time in three weeks.

MACRO OUTLOOK

The U.S. economy is forecast to have generated 140,000 new jobs in November, with signs of a sustained recovery in private sector hiring combined with solid auto sales and continued industrial growth boding well for the macro outlook.

The improving U.S. economic picture has been a factor lifting the entire U.S. government bond yield curve higher.

The benchmark 10-year U.S. Treasury yield edged down to 2.98 percent compared with a four-month high of 3.03 percent reached on Thursday. Since Monday, the yield has risen 16 basis points, half of the entire rise since November.

Though the U.S. labor market report will be center stage on Friday, investors will also been watching for follow-through on Thursday's unexpected narrowing in the spread of higher risk European government bond yields over German bond yields.

Market chatter about the European Central Bank stepping into the market to buy bonds of at-risk countries such Spain and Portugal caused the Spain/Germany 10-year yield spread to narrow to 230 basis points, the least in two weeks.

The Portugal/Germany 10-year yield spread was at 344 basis points, the narrowest since Oct 28.

(Editing by Alex Richardson)

Nonfarm payrolls likely rose 140,000, with private hiring increasing by more than 100,000 for a fifth straight month in November, according to a Reuters survey. The unemployment rate is forecast to have held steady at 9.6 percent.

Economists said there was a chance payrolls could surprise on the upside, citing a resurgence in retail hiring after a two-year slump. In October, U.S. employment increased by 153,000.

The Labor Department will release its closely watched monthly report on jobs at 8:30 a.m. ET.

"There is a lot of optimism that the economy is on the rebound and definitely has turned around," said Barbara Byrne Denham, chief economist of Eastern Consolidated in New York.

A second month of strong employment gains coming on the heels of reports indicating a pick-up in demand could shore up perceptions the economy's recovery from the worst recession since the 1930s is becoming self-sustaining.

That shift began to shape up in the third quarter as consumer spending's contribution to growth eclipsed the rebuilding of inventories. Consumer spending typically accounts for about two-thirds of U.S. economic activity.

But unemployment is seen remaining stuck at 9.6 percent for a fourth straight month in November because, with conditions in the jobs market improving, some discouraged workers probably rejoined the labor force.

Employment has increased by about 874,000 since December 2009, a tiny fraction of the over 8 million jobs lost during the recession.

Analysts believe that gap would compel the Federal Reserve to fully implement its controversial $600 billion program to buy government bonds. The purchases are designed to push already low interest rates down further to stimulate demand.

Concerns about joblessness and low inflation led to the U.S. central bank's decision last month to launch its now much-criticized second round of quantitative easing, as QE2 is known in financial markets.

QE2 HERE TO STAY

"We need to create 150,000 to 250,000 jobs consistently over a number of years before the unemployment rate can come down," said John Canally, an economist at LPL Financial in Boston.

"So even if we get a blow-out number of 300,000 in November and it increases calls for the Fed to stop QE2, they will want to see that over a number of months."

Fed officials are not the only ones worried about unemployment. The health of the labor market could determine whether President Barack Obama gets a second term in office in 2012.

ECB President Jean-Claude Trichet said the bank had decided at its monthly policy meeting to keep interest rates on hold and it extended its liquidity safety net to support vulnerable euro zone banks.

He made no mention of increasing the ECB's government bond buying program, despite calls to do so after an 85 billion euro ($110.7 billion) EU-IMF rescue of Ireland failed to dispel fears that Portugal or Spain may need a bailout.

"I say we are constantly alert. We are constantly looking at the situation of the markets," Trichet told a news conference.

But referring to a bond-buying policy that the ECB started after Greece was bailed out in May, he said: "The Securities Market Program (SMP) is ongoing, I repeat -- ongoing ... I won't comment on the observations of market participants."

Suggestions before Thursday's meeting that the ECB could agree new anti-crisis measures had helped the euro stabilize and lifted stock markets, despite lingering concerns about Spain and Portugal.

Adding to those concerns, Standard & Poor's warned late on Thursday that it may downgrade Greece's BB-plus credit rating in three months if it becomes clear that Europe's new mechanism to stabilize the debt crisis would favor public creditors to the detriment of private bond holders.

The failure to announce any major new action worried some economic analysts. But others' disappointment was tempered by the reports of ECB purchases of Portuguese and Irish bonds, which caused a drop in the premium that investors demand to buy these countries' debt over German benchmarks.

ECB bond buying, one trader said, has "been bigger than the last couple of weeks, since yesterday. Yesterday and today have definitely been bigger than usual."

Matthew Strauss, senior currency strategist at RBC Capital Markets in Toronto, said Trichet had not set a limit on the bond-buying program and this suggested the option of further bond purchases was "not necessarily off the table at all."

Morgan Stanley said in a research note that market hopes of a far-reaching announcement on bond purchases had been disappointed but: "At the same time, it seemed that ECB has continued to step up the pace of its purchases under the SMP."

EURO IN DANGER?

Some economists say the future of the euro is in doubt because of the sovereign debt crisis and fear contagion to Asia and the United States.

International Monetary Fund chief Dominique Strauss-Kahn, visiting India, said the situation in Europe was "serious" and the IMF was ready to provide financial and technical support to member states if needed.

But EU leaders deny the euro will collapse and dismissed reports on Thursday that they would call a special summit this weekend on the crisis.

The measure, which passed 234-188, is expected to die in the Senate, where Republicans have the votes to block it. Twenty Democrats voted against the House bill and three Republicans voted for it.

Despite the likely outcome, Senate Majority Leader Harry Reid may hold a vote on the House bill as early as Friday, Democratic aides said.

Most Democrats say Republicans were willing to jeopardize low tax rates for middle- and lower-income taxpayers to ensure low taxes for the wealthiest Americans.

The tax cuts were signed into law by former President George W. Bush in 2001 and 2003 and are set to expire December 31.

"The Republicans want to continue to keep middle-income tax cuts hostage until it is combined with upper-income tax cuts," said Democratic Representative Sander Levin, head of the tax-writing panel in the House.

Republicans countered that allowing any tax rates to rise would threaten the economy, which is suffering from high unemployment rates.

The House action comes as congressional leaders and the Obama administration negotiate behind closed doors for a compromise that would allow Congress to extend tax rates before they expire at year's end.

"The talks are ongoing and productive, but any reports that we are near a deal in the tax cut negotiations are inaccurate and premature," said White House press secretary Robert Gibbs.

On Capitol Hill, senior Democratic aides said they did not expect any significant progress until at least next week.

Another aide said many Democrats were worried the White House would not stand up to Republicans.

"There's a growing concern that the White House won't fight hard enough for the middle class and will cave (on extending tax cuts for wealthier Americans) without getting much in return, other than perhaps a Senate vote" on a stalled U.S.-Russian arms treaty, the aide said.

'THIS IS NONSENSE'

Democrats fear negotiations will go much as they did over the past two years on healthcare and the economic stimulus package, with President Barack Obama making concessions without getting much, if anything, in return from Republicans, the aide said.

The top House Republican blasted Thursday's vote on renewing only lower-tax rates as political maneuvering that would undermine the bipartisan talks.

After the meeting with Kansas City Federal Reserve Bank President Thomas Hoenig, the No. 3 Republican in the House of Representatives, Mike Pence, told reporters he continues to think the Fed should focus solely on fighting inflation.

Pence said last month that he planned to introduce legislation to change the Fed's mandate, which currently charges it with using monetary policy to achieve full employment as well as to keep inflation at bay. Sen. Bob Corker, an influential Republican on the Senate Banking Committee, has also backed the shift.

The proposal comes alongside domestic and international criticism over the U.S. central bank's plan to buy an additional $600 billion in government bonds to try to speed up a sluggish economic recovery.

Opponents, including a number of Republican lawmakers, worry the program will weaken the U.S. dollar and sow the seeds of inflation without doing much to lift economic growth and lower unemployment.

Many top Fed officials, including Chairman Ben Bernanke, have defended the action on the grounds that the economy is underperforming on both ends of the Fed's responsibilities with unemployment near 10 percent and inflation below the Fed's comfort zone.

Bernanke is expected to defend the bond-buying spree anew in an interview with the popular CBS newsmagazine show "60 Minutes" on Sunday.

Hoenig is one of the most inflation-focused "hawks" on the Fed and has dissented at every Fed policy vote this year on the grounds easy money could fuel asset bubbles.

When asked whether he supports efforts to pare the Fed's mandate to maintaining price stability, his office pointed to an October speech in which he said: "I am fully committed to the Federal Reserve's dual mandate to maintain long-run growth so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates."

Republican lawmakers have jumped to criticize the Fed's new stimulus effort since November elections swept them into control of the House.

Pence said members of Congress had wanted to talk to a policy-maker who also objects to the Fed's bond-buying plans, which are also referred to as QE2 because it is the second time the Fed has sought to lower rates by buying Treasuries, a tactic known as quantitative easing.

"Based on upon his public statement and his dissenting views on QE2, Thomas Hoenig is a member of the ... central bank that shares our concerns about the prospect of inflation and we're grateful that he came by," Pence said.

Fed officials say the central bank would likely be pursuing its bond-buying program even if it only had a mandate to ensure price stability because policy makers worry that low levels of inflation risk tipping into a dangerous deflationary spiral.

However, the move to simplify the mandate has not encountered the same vehement Fed opposition that greeted failed congressional efforts earlier this year to subject the central bank's monetary policy decision-making to lawmaker review, which officials said would have compromised the central bank's independence.

When Pence and Corker announced their support for changing the mandate, a Fed spokeswoman said the central bank was not seeking a change and that the dual mandate was appropriate.