FOREX-Dollar rises on hopes of U.S. debt ceiling deal

* House Republicans to propose short-term debt-limit hike

* U.S. jobless claims rise to six-month high

* Dollar still vulnerable if no debt resolution found

By Wanfeng Zhou

NEW YORK, Oct (KOSDAQ: 039200.KQ - news) 10 (Reuters) - The dollar rose to a two-week high against major currencies on Thursday as optimism grew that lawmakers in Washington might reach a deal to avert a potential U.S. debt default.

House of Representatives Republicans said they would propose legislation for a short-term debt limit increase to avoid a U.S. debt default. House Speaker John Boehner said the short-term debt limit increase is conditioned on an offer by Democrats to start negotiations on fiscal issues.

The dollar had come under pressure and U.S. short-term borrowing costs had jumped early this week as a government shutdown as a result of budget disagreements dragged on and as fears intensified over whether Congress will raise the debt ceiling by the Oct. 17 deadline.

"The market has front-loaded the impact of nearing the debt ceiling limit relative to the 2011 episode," said Jens Nordvig, global head of foreign exchange research at Nomura Securities in New York. He said in 2011, such stress was felt only immediately ahead of a deadline.

"This front-loading is opening up the possibility of two-way risk even as we approach the October 17 deadline. This is the reason markets, including money markets, are rallying today, on greater hope for a resolution."

The dollar index, which measures the greenback against a basket of six major currencies, rose as high as 80.595, the strongest since Sept. 26, extending its recovery from an eight-month low of 79.627 hit last Thursday. It was last at 80.433, up 0.1 percent on the day.

A rise in U.S. Treasury yields to their highest in more than two weeks and minutes from the Federal Reserve's September meeting suggesting that most board members supported tapering bond purchases later this year also boosted the dollar.

"There have been some positive developments regarding the debt ceiling and while they may be short-term measures, they offer some relief to the dollar," said Neil Mellor, currency strategist at Bank of New York Mellon.

"The Fed minutes are also talking about tapering later this year, all of which is nudging markets to cover positions before the weekend."

The dollar rallied 0.7 percent to 98.07 yen, rebounding from a two-month low of 96.55 yen hit on Tuesday. Traders said the dollar rebounded after finding strong support at its 200-day moving average, currently at 96.82.

The euro was up 0.1 percent at $1.3535.

The dollar briefly pared its gains versus the yen and hit a session low versus the euro after data showed the number of Americans filing new claims for unemployment benefits hit a six-month high last week.

Despite signs of rapprochement in Washington, the dollar could still be vulnerable to concerns about a debt default. Short-term U.S. government bill yields were at the highest since the 2008 financial crisis, reflecting investor anxiety.

"I would not be surprised to see some take profit in the dollar after the recent run. The situation has not really changed, and risk fear is mounting and the VIX is still just below 20 percent," said Francesco Scotto, portfolio manager at RTFX Fund Management Ltd.

Wall Street's favorite anxiety index, the VIX index, last traded down 15 percent at 16.66 after hitting 21.34 on Wednesday. A level above 20 is generally associated with increasing concern about the near-term direction of the market.

Banks and money market funds are beginning to shun some Treasuries normally used as collateral in the $5 trillion repurchase agreement market.

The Treasury Department says it will be unable to pay all of its bills if Congress does not raise the $16.7 trillion debt ceiling by Oct. 17. Republicans say the Obama administration would be able to keep up with its bond payments at the expense of other obligations if that deadline was missed. Treasury Secretary Jack Lew said that's not possible.

"It would be chaos," he told the Senate Finance Committee.