NEW YORK (MarketWatch) — The euro pared gains against the U.S. dollar on Friday after rallying earlier in the session to its highest level against the greenback since October 2011.

The euro EURUSD, -0.06% traded at $1.3742 on Friday afternoon. It had surged as high as $1.3893 earlier in the session, according to FactSet data, marking its highest level in more than two years. The euro changed hands at $1.3693 on Thursday.

The move came as European markets reopened after the Christmas and Boxing Day breaks.

The ICE dollar index DXY, +0.03% — which tracks the greenback against six rivals — pared intraday losses to trade at 80.369, compared to 80.488 late Thursday in North America.

The WSJ Dollar Index BUXX, +0.17% nearly erased its intraday losses to trade at 73.94 compared to 73.92 on Thursday.

“The European session has seen the dollar get squeezed quite significantly in a widespread selloff, allowing the other majors to make good ground on the greenback (apart from the yen),” said Angus Campbell, senior analyst at FxPro, in emailed comments.

“The volumes are so thin today that any small amount of position squaring is likely to be contributing to this dollar weakness, as European equity markets have reopened full of Christmas cheer to catch up with the strength shown by the Dow and S&P yesterday,” he said. “However, it wouldn’t surprise me if the dollar reversed much of its losses later today or certainly, come a return of more normal volumes next week.”

Investors also digested comments by Jens Weidmann, a member of the ECB governing council. He was quoted as telling Germany’s Bild newspaper that low price pressures cannot be a license for arbitrary monetary easing and that interest rates should be increased at the right time if inflation pressures rise, according to a report by Reuters.

Marc Chandler, global head of currency strategy at Brown Brothers Harriman, noted that currency trading is very thin and Friday’s action continued a trend that was already in place.

“As Spain’s current account surplus shows, the euro area is enjoying a large current-account surplus at the same time as it is seeing portfolio-capital inflows,” Chandler said in an email. “Many international fund managers continue to see greater value in European stocks and the short end of Italy and Spain’s debt market.”

In addition, “speculative flows should not be under-estimated,” he said. "Who else is really transacting now? I would also add the interest in long euro-short yen as well as funds leaving Turkey and some other emerging markets.”

The Turkish lira tumbled again Friday, hit by the growing political turmoil in the country.

The British pound GBPUSD, +0.02% pared gains to trade at $1.6469 after rising as high as $1.6577 earlier in the session, according to FactSet. It traded at $1.6419 on Thursday.

Shutterstock/Cristina Negoita

The dollar gained slightly against the Japanese yen, recapturing the 105-yen level. The greenback USDJPY, -0.01% recently bought 105.15 yen compared to late Thursday’s ¥104.74.

Japanese data included a slightly stronger-than-forecast pickup in consumer inflation. Japan’s core consumer-price index — which excludes volatile fresh-food prices — rose by 1.2% from a year earlier, accelerating from a 0.9% increase in October and above the consensus estimate of 1.1%.

Aggressive monetary easing and fiscal stimulus, which followed the election of Shinzo Abe as Japan’s prime minister in December last year, have sent the yen sharply lower over the past 12 months.

“2013 was the worst year for the Japanese yen in more than a decade,” wrote BK Asset Management managing director Kathy Lien in a note Thursday. “Taking a look at the continuous rise in dollar-yen today and its proximity to ¥105, it is almost hard to believe that on Jan. 1, it was trading at ¥86.”

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Lien said the yen’s fate for 2014 would rest on the timing and size of any future stimulus. Japan is due to increase its national sales tax in April in a bid to shore up government finances. In addition, some economists expect fresh monetary easing from the Bank of Japan, an offsetting cut to other taxes, or possibly both. “If they marry more [Bank of Japan] asset purchases with lower corporate taxes, dollar-yen could rise to fresh highs above ¥108, and possibly even ¥110,” Lien wrote.

But, she added, “if they forgo another round of stimulus next year, dollar-yen could be subject to a nasty correction ... because many investors are positioned for more easing.”

The Australian dollar AUDUSD, +0.02% erased gains to trade at 88.70 U.S. cents from 88.89 U.S. cents late Thursday.

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