By Carolyn Cohn
LONDON, Jan 4 - The yen recovered the bulk of the week's losses against the euro and the dollar on Friday as Japanese players returned from holiday to take profits on the euro's cash rollout-inspired New Year rally.
The euro failed to find support following service sector data showing businesses were becoming more optimistic in the euro zone. Trade was also cautious before key U.S. employment data for December, due at 1330 GMT.
Japanese authorities are generally thought to favour a weaker currency to spur exports and stem deflation, but traders are wary of potential gains in the yen from Japanese repatriation ahead of the fiscal year-end in March.
"Markets have been closed in Japan, and this is the first time people have had a chance to react to events in the equity world," said Francesca Fornasari, foreign exchange economist at Lehman.
"The euro zone data was very strong, but it is not particularly sensitive data, and everyone is waiting for the payrolls."
Tokyo stocks surged by more than three percent on Friday, chasing gains in U.S. technology stocks.
The Eurozone Business Activity Index rose to 49.2 in December from 46.9 in November, nearing the 50 threshold between growth and contraction. Confidence in the future reached a four-month high, with the business expectations index up 3.2 points to 58.9 in December.
Eurozone inflation was estimated at the European Central Bank's 2.0 percent ceiling in December, down from 2.1 percent in November.
By 1045 GMT, the euro was trading around two-day lows of 117.50 , down 2-1/2 yen from a 28-month high set on Wednesday, the first trading day after the smooth introduction of notes and coins.
The yen's gains against the euro gave it an edge against the dollar, with the greenback retreating to four-day lows of 130.90 yen from three-year highs around 132.30 set earlier this week. Against the dollar, the single currency was little changed from New York's closing levels around $0.8980 , more than half a cent below two-week highs set on Wednesday after a glitch-free cash rollout encouraged euro buying.
U.S. DATA FOCUS
The key focus remained on the U.S. employment report. Economists polled by estimated that U.S. employers in the non-farm sector shed 139,000 jobs in December after a 331,000 reduction in payrolls for November.
That would push the December unemployment rate up to 5.8 percent from 5.7 percent in the prior month.
"People are waiting for the U.S. figures, to see if all the interest rate cuts we have had have been enough," said a trader from a U.S. bank in Frankfurt.
The U.S. Federal Reserve cut interest rates 11 times last year in an attempt to kickstart the U.S. economy. A large decline in payrolls may prod the Fed into another interest rate cut at its January 29-30 policy meeting, but the market generally considered such a move unlikely.
While the data may still reveal a weak labour picture, investors were expected to keep in mind recent weekly jobless claims data that showed an improvement from the worst levels seen after the September 11 attacks. The U.S. Labor Department said on Thursday that claims rose sharply in the week ended December 29, but the figures were down from peaks in late September.
BUY MORE EUROS?
Europhoria was dying down as European citizens grew accustomed to euros in their wallets. But analysts said German Finance Minister Hans Eichel's planned visit to China and Iran to promote the use of the euro as a reserve currency could provide some euro-supportive comments in the coming days.
China has already announced it was increasing the ratio of euros in its foreign exchange reserves, the second largest in the world.
On Thursday, European Central Bank President Wim Duisenberg said the use of the euro in central banks' reserves was rising, albeit slowly.
"The talk of euro reserves could provide more concrete support for the euro," said Rob Hayward, senior FX strategist at ABN-Amro.