Although analysts partly attributed the euro's drop to year-end dollar demand and thin liquidity, they said unwinding of long euro positions were weighing on the currency. The euro has made rapid strides since mid-November, gaining around 5 percent in a month to hit an 8-1/2 month high of $1.33085 on December 19 as worries around the euro zone crisis ebbed.
"There is still a good chunk of scepticism among market participants about the euro being significantly higher than the $1.32-$1.33 level," said Ulrich Leuchtmann, head of FX research at Commerzbank. The euro's falls helped the dollar rise to a two-week high against a basket of currencies, with its index rising to 79.93. The also reversed earlier gains against the yen to trade down 0.4 percent at 113.51 yen, having earlier hit a 17-month low of 114.675 yen as expectations of more monetary stimulus continued to pressure the Japanese currency.
Commerzbank's Leuchtmann warned the euro would be susceptible to further losses in 2013 if concerns around the Europe's debt crisis re-emerge. "The long-term assumption that the euro zone crisis is over is a bit shaky and was perhaps overdone. Many of the speculators who increased their long euro positions in the last three months don't have the appetite to carry these long positions into the next year". Investors were cautious as they waited to see the outcome of a last-chance round of US budget talks, with analysts saying the dollar could benefit from safe-haven buying if no deal is reached by year-end.
The dollar was steady against the yen at 86.07 yen, edging away from an earlier peak of 86.64 yen, its strongest since August 2010, when it stopped just shy of reported options barriers at 86.75 yen and 87.00 yen. Expectations the new Japanese government will push the Bank of Japan to ease monetary policy further has weighed broadly on the Japanese currency and analysts say it could fall further.
The yen's unabated slide, since Shinzo Abe took the helm as Japan's prime minister on Wednesday, has seen it hit fresh two-year lows for three days in succession. Abe has vowed to press for aggressive monetary stimulus to fight deflation. The dollar looked set to end the week above its 200-week moving average, now around 84.95 yen, for the first time since late December 2007, a technical signal indicating further gains.