By Karen Brettell

NEW YORK (Reuters) - The U.S. dollar fell against a basket of currencies on Thursday after U.S. manufacturing activity unexpectedly declined in August, casting some doubts on the strength of U.S. economic growth.

The Institute for Supply Management (ISM) said its index of national factory activity fell 3.2 percentage points to a reading of 49.4, the first contraction since February.

"The ISM was a bit disappointing," said Shaun Osborne, chief forex strategist at Scotiabank in Toronto.

The data overturned earlier dollar strength as investors wait on highly anticipated jobs data due on Friday for new clues on when the Federal Reserve will next raise interest rates.

"Payrolls will be quite important for the dollar from a near-to-medium point of view,” Osborne said. "A strong number tomorrow is likely to convince people that a rate hike this year is quite possible, and it may even mean that September is realistically feasible for the Fed to move."

Fed Vice Chair Stanley Fischer said last week that the jobs data for August will be a consideration for when the Fed raises rates. Employers are expected to have added 180,000 jobs in August, according to the median estimate of 91 economists polled by Reuters. [ECONUS]

His comments followed a relatively hawkish speech by Fed Chair Janet Yellen, which has raised expectations the U.S. central bank is moving closer to a hike.

The dollar index <.DXY>, which measures the greenback against a basket of six major currencies, fell 0.40 percent to 95.635, after earlier trading as high as 96.239.

The greenback also declined to 103.28 yen <JPY=>, after earlier rising to 104.00, the highest since July 29.

Sterling jumped 1 percent against the dollar and hit a one-month high against the euro on Thursday after data showing the British manufacturing sector staged one of its sharpest rebounds on record in August.

The Markit/CIPS Purchasing Managers' Index (PMI) jumped to a 10-month high of 53.3 in August, recovering from the three-year low it hit in July after Britain's June 23 vote to leave the European Union.

Sterling rose to $1.3270 <GBP=D4>, from $1.3152 before the data, while the euro fell 0.65 percent to 84.41 pence per euro <EURGBP=D4>, down from 84.68 pence beforehand.

"Sterling is the outperformer because of the UK PMI data, which has squeezed the sterling shorts a bit further,” said Vassili Serebriakov, a currency strategist at Credit Agricole in New York.

(Editing by Chizu Nomiyama and Frances Kerry)