* Dollar rises after hitting lowest since Dec. 8
* Yellen remarks seen as bullish for dollar
* Sterling drops after largest one-day rise since at least 1998
* U.S. inflation data suggest Fed still on pace for 2017 hikes (Updates to U.S. market close, adds quotes, data)
By Dion Rabouin
NEW YORK, Jan 18 (Reuters) - The dollar rose on Wednesday, boosted by comments from Federal Reserve Chair Janet Yellen that suggested the U.S. central bank was ready to raise overnight interest rates quickly in the coming year.
Yellen said in prepared remarks that waiting too long to begin raising rates could "risk a nasty surprise down the road."
Already higher after a rebound that followed a volatile Tuesday, the dollar rose across the board, gaining 0.7 percent against the euro, 1.2 percent against sterling and 1.5 percent against the Japanese yen.
On Tuesday, sterling had its best showing against the dollar since at least 1998.
The dollar index, which measures the U.S. currency against a basket of six major peers, stood at 101.260, up 0.95 percent. It fell to its lowest since Dec. 8 on Tuesday.
"The chair's remarks were consistent with the Fed adopting a quicker pace of tightening this year, a backdrop that's bullish for the dollar," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington.
"I didn't see any increase in bullishness or hawkishness in her remarks today, but given the dollar's difficulties over the past couple days it shined a spotlight on rosy U.S. fundamentals, which are supportive of the U.S. currency."
U.S. consumer prices in December had the largest year-on-year increase in 2-1/2 years and U.S. industrial production recorded its biggest gain in two years.
While the data did not initially rock the boat, it backed the theme of overall U.S. economic strength, said John Doyle, director of markets at Tempus Inc in Washington.
"It just adds to the Fed's story and an argument that the economy is ready to weather interest rates hikes."
The dollar added substantial gains against the currencies of North American Free Trade Agreement partners Canada and Mexico, adding 1.7 percent against the Canadian dollar and more than 2 percent versus the beleaguered Mexican peso, which again neared its lowest level on record.
The Bank of Canada said an interest rate cut remained "on the table" in its latest monetary report released on Wednesday, as BOC Governor Stephen Poloz warned of negative consequences if U.S. President-elect Donald Trump enacted protectionist policies.
Trump's nominee to lead the Commerce Department, billionaire Wilbur Ross, said during a hearing with U.S. lawmakers that rewriting NAFTA would be his first priority if he took the position.
Both Mexico and Canada's economies rely heavily on exports to the United States.
Reporting by Dion Rabouin; Editing by Chizu Nomiyama and Richard Chang