* Dollar touches fresh 7-year high vs yen
* Upbeat payrolls data re-energise dollar bulls
* Aussie touches fresh 4-year low (Updates levels, adds comments)
By Masayuki Kitano and Ian Chua
SINGAPORE/SYDNEY, Dec 8 (Reuters) - The dollar set a fresh seven-year high against the yen on Monday after surprisingly robust U.S. jobs data bolstered the view that the Federal Reserve could raise interest rates sooner than expected.
The surge in payrolls by 321,000 in November easily blew past Wall Street's expectations and served to further highlight the divergence in economic outlook between the United States and most of the developed world.
Short-term Treasury yields rose after the strong U.S. jobs data, widening the premium paid by U.S. two-year paper to around 67 basis points over comparable German bonds, the widest in more than seven years.
The yield gap between two-year U.S. Treasuries and two-year Japanese government bonds expanded to around 66 basis points, the widest yield advantage for the dollar since mid-2010.
That helped bolster the greenback, which rose to 121.86 yen earlier on Monday, its highest level since July 2007. The greenback later pared back its gains and traded at 121.50 yen , little changed from late U.S. trade on Friday.
However, there was little reaction in the market to data showing Japan's third quarter economic contraction was deeper than initially reported.
The next major peak on technical charts comes in at 124.14 yen, the dollar's June 2007 high.
Forthcoming events such as Japan's general election on Dec. 14 and the U.S. Federal Reserve's Dec. 16-17 policy meeting are unlikely to alter the dollar's overall trend, said a trader for a Japanese bank in Singapore.
While the dollar could falter if the Fed were to sound cautious about the economic outlook, "that may just be a good opportunity to buy (the dollar) on dips," he said.
Against a basket of major currencies, the dollar held steady at 89.362, hovering near a five-year high of 89.467 set on Friday.
A break above the March 2009 high of 89.624 would take the dollar index to its highest level since April 2006.
The euro inched up 0.1 percent to $1.2289, still near a two-year low of about $1.2270 set on Friday.
Not helping sentiment for the common currency, Standard & Poor's on Friday cut Italy's sovereign credit rating to BBB-, just one notch above junk.
For some analysts, the upbeat U.S. jobs report added to the case for the Fed to raise interest rates sooner rather than later, although the general expectation is for the rate increases to start around middle of 2015.
In stark contrast, the European Central Bank is under pressure to expand its asset-buying stimulus program.
While the ECB disappointed some by its inaction last week, President Mario Draghi gave his clearest signal yet that quantitative easing may be on the cards early in 2015.
"EUR/USD is on its way to below 1.20 for the first time in a decade," analysts at Societe Generale wrote in a note to clients, adding the greenback "still has plenty of room to the upside, and will be supported in 2015 by a sharp divergence in monetary policy."
Data showing a surprise drop in China's imports in November weighed on the Australian dollar, which touched a fresh four-year low on Monday. China is a major destination for Australia's commodities exports.
The Aussie dollar last traded at $0.8281, down 0.4 percent on the day. (Editing by Shri Navaratnam)