Euro rallies vs dollar as data revives risk appetite

The yen erased most early gains versus the dollar and dropped sharply against other currencies as U.S. stocks rallied, helping improve sentiment a day after Federal Reserve chairman Ben Bernanke painted a gloomy outlook for the U.S. economy.

Traders have reverted to risk-seeking mode this morning, said Kathy Lien, director of currency research at GFT Forex in New York, citing the rise against the yen on the U.S. housing data. The dollar received a boost because the data was not nearly as bad as everyone had feared and because the median price of a home sold rose 1.0 percent.

U.S. existing home sales fell 5.1 percent in June, an industry group reported, less than the 8.1 percent decline expected according to a Reuters poll.

The euro EUR= was last up 1.1 percent at $1.2906, after hitting a session peak at $1.2933 on electronic trading platform EBS. It also gained 1.1 percent to 112.31 yen EURJPY=.

James Chen, chief technical strategist at FX Solutions said the euro/dollar tentatively broke above resistance at $1.2900 and further gains are likely.

If another attempt at a $1.3000 breach takes place, key upside resistance on such a bullish move resides in the significant $1.3100 price region, he said.

The dollar was down 0.1 percent at 87.01 yen JPY=, rebounding from a session low of 86.35, according to Reuters data.

A survey showed the euro zone's private sector surged aheah, with the pace of growth accelerating in both the services and manufacturing sectors.

There's been a reversal in risk appetite and market sentiment, said Vassili Serebriakov, currency strategist at Wells Fargo in New York. The markets are focusing on the fact that European economic recovery appears to be well on track.

The dollar was trading down 1 percent versus a currency basket .DXY at 82.557 after slipping to a low 82.462.

Attention focused on the release of European bank stress test results, due at 1600 GMT on Friday, although some sources said the results might be released earlier.

The euro has had a good run against the dollar in anticipation of the test results, rising to a 10-week high above $1.30 on Tuesday as traders bet most of the 91 European banks being examined would pass.

Some in the foreign exchange markets say the test results could be positive for the euro if they reveal no unpleasant surprises, but doubts linger whether the checks are tough or transparent enough.

The market has certainly bought the rumor going into this week that the stress tests will be positive and people have been going long euro/dollar, said Lauren Rosborough, currency strategist at Westpac. (Editing by Leslie Adler)