By Anshuman Daga

SINGAPORE (Reuters) - Asian stocks logged their sharpest declines in two weeks but the dollar held on to gains following strong U.S. data that again suggested the Federal Reserve might stick longer with aggressive interest rate increases.

While investors stayed hopeful of China's economy improving with the easing of the country's zero-COVID policy, analysts said markets had already priced in a lot of the upbeat news.

MSCI's broadest index of Asia-Pacific shares outside Japan declined 1.4%, the biggest fall since Nov. 21, after climbing to a three-month high in the previous session. The benchmark has gained 20% from October lows on persistent chatter about China easing pandemic measures.

Stocks in Korea fell 1%, Taiwan slumped by 1.6%, and Hong Kong shed 1.1%. Chinese stocks extended their recovery, with the broader index gaining 0.6%, while Japan was up 0.3%.

"The black swan in the room is the risk of the Fed being too late again, but this time in cutting rates," said Havard Chi, head of research at hedge fund Quarz Capital Asia.

Tuesday's declines in Asian equities came after global stocks and Treasury prices fell on Monday as new evidence of a strong U.S. economy raised expectations that interest rates would stay higher for longer.

"Monetary policy works with a lag and key spot indicators such as falling housing prices, rental rates, commodities, and freight pricing as well as rising layoffs and inventories are already signalling a weakening U.S. economy," said Chi.

U.S. services industry activity unexpectedly picked up in November and employment rebounded. It was the latest data showing economic momentum that could push the Federal Reserve to tighten policy further, and it followed a robust U.S. payrolls report for November.

Futures show the market expects U.S. short-term interest rates to peak at 5.001% in May. The expectation is about 9 basis points higher than it was last week. By December 2023, the rates will have declined to 4.574%, according to futures markets. The dollar stayed firm versus major peers, following its biggest rally in two weeks on Monday, which was helped by the strong U.S. services data.

The Australian dollar regained some ground after the country's central bank raised interest rates to decade highs and stuck with a prediction of further hikes ahead, quashing any thought it was near to pausing.

While Chinese stocks have rallied in recent weeks, they are among the worst performers in Asia so far this year, despite the country easing lockdown restrictions.

On Tuesday, Beijing dropped the need for people to show negative COVID tests to enter supermarkets and offices, the latest in an easing of curbs across the country following last month's historic protests.

"We are taking a 'buy the dips' approach in increasing our allocation as we believe that a full-reopening of the Chinese borders will only be from mid-Feb onwards, said Chi, adding that the investment firm was generally bullish on Asian equities.

Oil prices edged up, after a G7 price cap on Russian seaborne oil came into force on Monday on top of a European Union embargo on imports of Russian crude by sea.

futures ticked up 0.5% to $83.1 a barrel. Futures fell more than 3% in the previous session after the U.S. economic data.