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* Wall Street gains on better-than-expected February payrolls data * European shares rise further, MSCI world index hits 4-3/4-year high * Dollar touches 3-1/2-year peak against yen * U.S. Treasury yields jump as jobs report suggests improving economy By Herbert Lash NEW YORK, March 8 (Reuters) - World equity markets rallied and the U.S. dollar strengthened on Friday after an unexpectedly sharp jump in U.S. employment in February reinforced the view that the world's biggest economy is gaining traction. The Dow Jones industrial average posted its fourth consecutive intraday record high, while European shares and a gauge of global equity markets rose to their highest levels in more than 4-1/2 years. The dollar touched a 3-1/2-year high against the yen and a three-month peak against the euro, but U.S. Treasuries sank on the payrolls report, which showed the U.S. unemployment rate fell to a four-year low of 7.7 percent last month. Nonfarm payrolls surged by 236,000 jobs in February, the Labor Department said, handily beating economists' expectations of a gain of 160,000. "We're seeing growing inflows coming into the asset class. This is sort of a sweet spot, with improving U.S. job data while central banks around the world are pledging to keep printing money," said David Thebault, head of quantitative sales trading at Global Equities in Paris. U.S. stocks pared some early gains, led by declines in JPMorgan Chase, Bank of America and Goldman Sachs & Co. Banks had advanced recently in anticipation of the Federal Reserve's stress test results that showed they had enough capital to withstand a severe economic downturn. "That is what people were expecting, so now these investors are deciding to take some profits, and that's what is happening," said Ken Polcari, director of the NYSE floor division at O'Neil Securities in New York. The February report showed a labor market that continues to move sideways at a frustratingly slow trend for the Fed, said Ellen Zentner, senior U.S. economist at Nomura Securities in New York. The length of time people are unemployed deteriorated, the number of discouraged workers increased, voluntary job labor fell and the labor force participation rate declined, all items Fed policymakers pay close attention to, she said. "This is not a report that is going to inspire any kind of change in monetary policy, it is certainly not going to inspire any kind of discussion around this stellar job report that makes them decide to end QE earlier than expected," Zentner said. The Dow Jones industrial average was up 60.71 points, or 0.42 percent, at 14,390.20. The Standard & Poor's 500 Index was up 7.03 points, or 0.46 percent, at 1,551.29. The Nasdaq Composite Index was up 12.82 points, or 0.40 percent, at 3,244.91. The broad rally prompted some investors to seek out areas of relative value in southern Europe, which had been hit anew recently over resurgent political risk in the region. Italy's FTSE MIB benchmark index and Spain's IBEX chalked up the biggest gains among major European indices, surging 1.6 percent and 2.9 percent, respectively. The FTSEurofirst 300 index of top European shares closed 0.85 percent higher at 1,195.20. Earlier, MSCI's all-country world equity index rose to its highest level since late June 2008, and Japan's Nikkei hit a 4-1/2 year high in Asian trading. The MSCI index was up 0.37 percent at 360.24. U.S. Treasuries pared some losses as Wall Street retreated a bit. Yields have pushed steadily higher this week as early data pointed to a bigger rise in payrolls than previously expected and thus a swifter healing of the labor market. Prices for benchmark 10-year notes dropped 18/32 to yield 2.0576 percent. The euro fell against the dollar, erasing gains from Thursday, when European Central Bank President Mario Draghi gave less-dovish policy signals than expected. The euro fell 0.76 percent to $1.3004, extending losses against the dollar after Fitch cut the credit rating of Italy's sovereign debt following recent elections. Against the yen the dollar climbed as high as 96.54 yen, the highest since August 2009. It was last at 95.87 yen, up 1.1 percent in its biggest one-day gain since Feb. 11. Brent crude futures fell as the U.S. jobs data strengthened the dollar. Brent futures settled down 30 cents at $110.85 a barrel. Brent closed out the week higher, breaking three straight weeks of decline. U.S. oil rose 39 cents to settle at $91.95.