FOREX-Dollar weakens against euro, despite improving US data

* Dollar pares earlier losses on strong labor data

* Investors wary about dollar bets after volatile selloff

* Euro gains as data signals nascent recovery (Updates trading, adds comment, background, byline, dateline; previous LONDON)

By Karen Brettell

NEW YORK, May 21 (Reuters) - The U.S. dollar weakened against the euro on Thursday for the first time this week, as investors burnt by a dramatic selloff over the past month were reluctant to enter new positions, and as euro zone activity showed nascent signs of recovery.

Investors remained wary of making new bets that the U.S. dollar will regain strength even as U.S. data showed economic momentum was improving.

"People are reluctant to put on strong dollar positions, so they are lagging what you can see in terms of economic data," said Sebastien Galy, senior foreign exchange analyst at Societe Generale in New York.

The number of Americans filing new claims for unemployment benefits rose slightly more than expected last week, data on Thursday showed.

The four-week moving average of claims, considered a better measure of labor market trends as it irons out week-to-week volatility, fell 5,500 last week to 266,250. That was the lowest level since April 2000.

"Today we had a confirmation that the labor data is pretty darn good, an indication that the nonfarm payroll will be pretty darn good also, and that is not logical with what we see in the dollar," Galy said.

The dollar pared earlier losses against the euro on the jobless claims data and last traded at $1.11 against the single currency.

The euro was also bolstered Thursday by nascent signs of a recovery in euro zone activity and a rise in German Bund yields which narrowed the spread over U.S. Treasuries.

The composite flash PMI for the euro zone fell to 53.4 from 53.9, missing the 53.8 forecast in a Reuters poll. Despite the drop, data compiler Markit (NasdaqGS: MRKT - news) said, the euro zone economy is on track to grow 0.4 percent in the current quarter.

"The narrowing of yield spreads over U.S. Treasuries is having an impact on euro/dollar," said Jeremy Stretch, head of currency strategy at CIBC World Markets.

Part of the reason that euro gains will be limited is a very accommodative monetary policy stance by the European Central Bank. Earlier this week, board member Benoit Coeure said the central bank looked to accelerate the pace of money printing to buy government bonds over the next two months.

The prospect of more euros flooding the market sent the common currency lower across the board earlier this week.

(Additional reporting by Anirban Nag in London; Editing by Bernadette Baum)