* U.S. ISM report turns things around for dollar * RBA surprises markets with 50 bps rate cut, Aussie tumbles * Yen hits 2-1/2-month high vs dollar, but falls By Julie Haviv NEW YORK, May 1 (Reuters) - The dollar rebounded from a one-month low against the euro and a 2-1/2-month trough versus the yen on Tuesday after a key barometer of the U.S. manufacturing sector showed unexpected strength last month, assuaging concerns the economy was slowing. The Institute for Supply Management's factory data bucked the trend of other recent data that suggested the economy was losing steam, prompting traders to rebuild long dollar bets that had grown stale as the economy's outlook weakened. . "The view on the economy has swung from optimism to pessimism of late and this could bring us back to the middle," said Nick Bennenbroek, head of FX strategy for North America at Wells Fargo in New York. "ISM suggests there's no real reason to get too concerned about the path of the U.S. economy at this point." The ISM data, which showed the strongest rate of growth in 10 months, also downplayed recent speculation that the Federal Reserve will embark on a third round of bond buying to bolster the economy, lifting the appeal of the dollar. In afternoon New York trading, the euro fell 0.2 percent against the dollar to $1.3218, retreating from a four-week high at $1.3283 hit earlier in the day. "Once the euro rally lost momentum that led to massive interest in June euro $1.32 and $1.30 puts," said Matthew Schilling, a commodities brokers at RJO futures in Chicago. "Those puts are showing the highest volume that I have seen in a while." Investors who buy these puts expect the euro to fall below $1.30 or $1.32 before they expire on June 8. Trade was thin, however, with many of Europe's trading centers closed for the May Day holiday. Light volume was expected before Thursday's European Central Bank meeting, Friday's U.S. non-farm payrolls report and weekend elections in Greece and France. Against the yen, the dollar recovered from a more than two-month low, rising to a session high at 80.29 yen. It was last at 80.24 yen, up 0.6 percent. Front-end volatility in dollar/yen remained under pressure despite the dollar hitting multi-month lows. On Tuesday, one- month volatility was at 8.35 percent, falling as low as 7.76. Volatility curves in dollar/yen, however, are positively sloping, with back-month options still higher than short-dated ones - usually reflecting expectations of some stress. Ultimately, however, analysts said long-end volatility should decline as well because it has become expensive for investors to be on such a constant state of alert, given time decay. The Australian dollar, meanwhile, was the day's biggest mover, falling sharply after the Reserve Bank of Australia slashed rates by a deeper-than-expected 50 basis points. The Aussie fell 0.9 percent to US$1.0334 and slid to a three-month low near 82 yen. "The RBA move means we no longer see a cut in June, but data in the coming months will be of particular focus in the wake of this rather unprecedented cut," TD Securities said in a research note. "We are now calling for another 25-basis-point cut in Q3."

Source