* U.S. dollar falls 0.5 percent vs basket of currencies
* China PMI shrinks for first time in 7 months
* U.S. weekly jobless claims at 1230 GMT eyed (Updates prices)
By Clara Denina
LONDON, May 23 (Reuters) - Gold bounced back on Thursday from the previous session's losses as the dollar fell sharply and European shares dropped after weak economic data in China and Europe.
A euro zone purchasing managers' index showed that while the slump in business activity eased slightly in May, it pointed to a further contraction in the second quarter. The flash HSBC purchasing managers' survey showed Chinese factory activity shrank in May for the first time in seven months.
Spot gold rose 1.6 percent to $1,391.46 an ounce by 1200 GMT. U.S. gold futures rose 1.8 percent to $1,391.30 an ounce.
"Expectation that China's growth is perhaps not as strong as it was, the equity rally, which has wobbled a bit just in past few hours and dollar weakness are lending support to gold," Mitsubishi analyst Jonathan Butler said.
The dollar index fell 0.5 percent against a basket of currencies, mostly due to a two-week high in the yen, while European shares fell on concerns over an end to quantitative easing in the U.S. and weak economic data from China.
Gold holds a traditional inverse relation with the dollar and a weaker greenback makes dollar-denominated commodities cheaper for holders of other currencies.
The U.S. currency however remains around 20 percent stronger on the year and is expected to retain some gains in the coming months as the country's economy continues to improve.
"Over the coming months the general trend is for a modest economic recovery in the developed markets and that's going to fuel growth in the equity markets and the dollar," Butler said.
"This, together with expectations of tightening quantitative easing, should see gold coming under pressure."
Spot bullion fell more than one percent on Wednesday after Fed Chairman Ben Bernanke said a decision to reduce the central bank's bond-buying programme could be taken in the 'next few meetings.'
"It seems the market is now squarely focusing on the September 17-18 FOMC meeting for the Fed to make its move," ING said in a note.
Gold previously reached a one-week high at $1,414.25 as the Fed chairman's prepared testimony to the Congress sounded more dovish.
The market is turning its attention towards U.S. weekly jobless claims later in the day.
As a gauge of investment, holdings in SPDR Gold Trust, the world's largest gold-backed exchange-traded fund, fell 0.3 percent to 1,020.07 tonnes on Wednesday, the lowest in more than four years.
Weaker economic data from China, which raises concerns over whether the country can sustain an economic revival this year, come at a time physical gold demand in Asia is normalising.
Traders saw record gold demand in price-sensitive physical markets like China and India after the metal fell to a more than two-year low of $1,321.35 an ounce on April 16.
But that demand was now tapering off as jewellers had largely replenished their stocks and retail investors satisfied their needs, analysts said.
Spot silver rose 1.6 percent to $22.54 an ounce, while platinum fell 0.4 percent to $1,459.99 an ounce and palladium lost 1.1 percent to $735.50 an ounce. (Additional reporting by A. Ananthalakshmi in Singapore; editing by James Jukwey)