In your particular case with a low cycles-per-rev encoder and, I image, slow rotational speed (?) it might be possible to go for an all analog approach, otherwise you need to add some comparators to produce digital quadrature signals which you use to count steps and to know which quadrant you're in. Then you use the analog signals for interpolation between those "digital steps".
If you have not already, take a look at Texas Instrument app.note TIDUA05A as it goes into quite some details on what's involved.
Keep us posted! I've got a 2048 cpr encoder I've been meaning to play with - perhaps this is a sign to dig it out....
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