* European stocks hold near three-month high
* Euro hits fresh 7-1/2-month low
* Dollar hits highest since March 2003
* U.S. crude falls below $40 (Adds oil settlement prices, close of U.S. markets)
By Chuck Mikolajczak
NEW YORK, Dec 2 (Reuters) - The dollar strengthened on Wednesday and stocks fell on Wall Street, as Federal Reserve Chair Janet Yellen signaled a readiness to hike interest rates and U.S. data indicated a solid labor market.
Yellen said she was "looking forward" to a U.S. rate hike that will be seen as a testament to the economy's recovery from recession, although she did not indicate if she still expected a hike would be warranted at the Fed's last policy meeting of the year on Dec. 15-16.
"I was a little surprised she sounded as hawkish as she did given we're two days away from the nonfarm payrolls report and a couple of weeks away from the Fed FOMC meeting," said Michael O'Rourke, chief market strategist at JonesTrading in Greenwich, Connecticut.
"She gave the impression the Fed is still looking to make a move here in December even despite yesterday's weak ISM numbers."
Yellen also is due to testify on the economic outlook before a joint Congressional committee on Thursday.
U.S. private employers boosted hiring in November. The ADP National Employment Report showed private payrolls increased 217,000 last month while a separate report showed nonfarm productivity grew at a faster pace than previously thought in the third quarter.
The Fed said in its Beige Book report of anecdotal information on business activity collected from contacts nationwide that the U.S. labor market tightened modestly in recent weeks, with some upward pressure on wages.
The U.S. dollar index extended gains after Yellen's remarks to a high of 100.51, its highest since March 2003, before paring gains. It was last up 0.21 percent at 100.00.
European stocks pared gains late but managed to hold near a 3-1/2-month high and the euro hit a fresh 7-1/2-month low of $1.0549 against the dollar in the wake of Yellen's comments and on expectations the European Central Bank will engage in more stimulus after its meeting on Thursday.
The Dow Jones industrial average fell 157.54 points, or 0.88 percent, to 17,730.81, the S&P 500 lost 23.02 points, or 1.09 percent, to 2,079.61 and the Nasdaq Composite dropped 33.08 points, or 0.64 percent, to 5,123.22.
MSCI's all-country world index of equity performance in 46 countries declined 0.68 percent. The pan-European FTSEurofirst edged up 0.01 percent.
Benchmark 10-year U.S. Treasury notes were off 8/32 in price to yield 2.1832 percent.
The strengthening dollar put pressure on commodities, with oil also pushed lower as the world's biggest producers signaled no production cuts at their meeting this week.
Brent oil prices dropped for a fifth straight session and settled down 4.4 percent at $42.49 a barrel, while U.S. crude settled 4.6 percent lower at $39.94.
Copper lost 1.5 percent to $4,562.75 a tonne after falling as low as $4,522.00, and spot gold was off 1.6 percent at $1,052.26 an ounce.
Additional reporting by Sinead Carew; Editing by David Gregorio and James Dalgleish