The euro held near two-month highs on Friday, while the yen was under pressure as investors cut long positions and veered toward high-yielding currencies on improving risk appetite.
The euro was little changed on the day at $1.2694, after advancing nearly 0.5 percent on Thursday and jumping more than 1 percent against the low-yielding yen on a break of significant resistance that took it as far as $1.2713.
Some profit-taking in Asian time pinned it below Thursday's high. It then faces initial resistance from a downtrend line off its December high, which comes in at roughly $1.2715-25, and at more chart points around $1.2767 and $1.2780.
Market players are likely to cover more short euro positions, with charts signaling the euro has hit a bottom against the dollar and the yen, said Masahiro Kami, capital market analyst at Sumitomo Mitsui Banking Corp.
At the same time, the euro's rebound may be limited as investors are unlikely to buy back all euro positions they cut.
It was supported on Thursday by a cautiously optimistic European Central Bank, strong European industrial production data and a sizable drop in U.S. initial unemployment claims..
Clarity on European bank stress tests also helped the euro, as well as bank shares, as investors realized criteria for them were no more onerous than markets expected.
Chartwise it has scope to reach $1.2767 as the target off an A-B-C wave sequence starting from the euro's four-year low at $1.1876, with the C-wave starting at $1.2152. The $1.2780 area is a 50 percent retracement of its fall from mid-April to the June low.
But traders and strategists remain wary of going long euros in a big way, given the fiscal and debt problems that hobble its economy, and some expect bigger profit-taking and a sell-off soon. Support is seen at the 55-day moving average of $1.2481.
Even though the euro has had a bit of a renaissance, the longevity of these gains is open to question, and is reflected in a wide gap between the one-month and one-year risk reversals, David Watt, senior currency strategist at RBC Capital.
Short-term bearishness has dissipated to some extent, but longer-term markets are still prepared to pay a hefty premium for puts over calls.
Indeed, while 1-month risk reversals have fallen nearly 55 basis points to quote at 0.85/1.35 percent since the end of June, 1-year risk reversals have lost about 25 basis points in the same period.
The euro touched a two-week high of 112.57 yen after jumping more than 1 percent on Thursday.
The yen was under pressure as investors cut long positions and shifted funds toward high-beta currencies like the Australian and New Zealand dollars.
The dollar inched up 0.3 percent to 88.61 yen, having gained about 0.7 percent on Thursday. It has managed to pull away from a seven-month low of 86.96 yen struck on July 1.
Japanese importer demand lifted the dollar against the yen in early trade, traders said.
The ruling Democratic Party of Japan is looking increasingly likely to miss its target for seats in an upper house election at the weekend, an outcome that could weaken the prime minister and complicate policy-making.
But analysts said the yen's slippage stemmed from a higher appetite for riskier currencies, although a worse-than-expected election outcome for the DPJ could briefly be yen-negative.
The yen had made solid gains against the greenback earlier this month on the back of growing worries about an economic slowdown in the United States and falling stock markets.
But those worries seem to have taken a back seat, with some of the gloom lifting due to expectations of strong earnings in the U.S., boosting risk appetite, although analysts cautioned sentiment is fragile. The market will be watching a host of Chinese indicators due over the next week, starting with trade data on Saturday and including second quarter GDP on July 15.
The Australian dollar was flat at $0.8771, but off a two-week high of $0.8792 hit on Thursday. Momentum toward the Aussie was strong given a solid jobs reading which brought back the risk of near term rate increases.
The Australian dollar rose 0.3 percent to 77.69 yen, having surged 5 percent this week.
The Obama administration declined to label China a currency manipulator in a report on Thursday, spurring fresh calls from U.S. lawmakers for tough new steps to pressure Beijing.
Traders said Washington's decision had little impact on foreign exchange rates as investors saw the yuan's weakness as no longer an internationally hot issue after China last month freed its yuan from a nearly two-year-old peg to the dollar.
(Additional reporting by Anirban Nag in Sydney and Charlotte Cooper in Tokyo; Contribution by Reuters FX analyst Krishna Kumar in Sydney; Editing by Michael Watson)