A rally that pushed the euro to its highest level in more than two months stalled on Friday and the currency fell due largely to technical factors as investors took profits before the weekend.

The euro rose 1.3 percent this week and touched $1.2723 earlier in the session, its highest level since early May, supported by strong German factory data, a positive U.S. jobs report and more clarity on European bank stress tests.

But traders said the single currency struggled to maintain gains above $1.27, due to lingering worries about the euro zone economy.

The euro tested but did not break technical resistance levels overnight and has subsequently given up a share of its recent gains, said Vassili Serebriakov, a currency strategist at Wells Fargo Bank in New York.

While there have not been any obvious catalysts for the euro's pullback this morning, the speed of the move suggests the underlying sentiment on the currency remains negative, he added.

In late morning trading in New York, the euro erased earlier gains to trade down 0.4 percent at $1.2645 EUR=, after reaching $1.2723 on trading platform EBS.

Despite its recent rally, the euro zone's debt problems have discouraged investors from taking long positions in the euro. Some Asian central banks were seen willing to re-establish long euro/dollar positions above $1.2750 because a clear breach of $1.2730 would suggest the downtrend had been broken.

There is still a risk that euro shorts get covered and the bounce extends but it is no more than that: a short-term bounce, said Adam Cole, global head of foreign exchange strategy at RBC Capital Markets.

That view was reflected in the gap between 1-month risk reversals EUR1MRR=ICAP, which have fallen nearly 55 basis points to 0.85/1.35 percent since end-June, and 1-year risk reversals EUR1YRR=ICAP, which have shed 25 basis points. This indicates traders are willing to pay a higher premium to buy the right to sell the euro in coming months.

Ian Stannard, a foreign exchange strategist at BNP Paribas, said that increased demand for high-yielding commodity currencies such as the Australian and Canadian dollars would also hit the euro, which has come to be seen as a funding currency.

CANADIAN DOLLAR RISES

One of Friday's biggest movers was the Canadian dollar CAD=D4, which surged 1 percent against the greenback on a stronger-than-expected improvement in jobless figures.

The U.S. dollar was last trading lower at C$1.0323, its lowest since late June.

Canada's figures mirror robust jobs data from Australia earlier this week that drove the Australian dollar up more than 4 percent.

Strong data has boosted hopes of a firmer economic recovery and raised pressure on the low-yielding yen JPY= as investors cut long positions and shifted into high-beta currencies like the Aussie AUD=D4 and New Zealand dollars NZD=D4.

The euro touched a two-week high earlier of 112.69 yen EURJPY=R on EBS after jumping more than 1 percent on Thursday but pared those gains to trade last at 111.68 yen.

The dollar was little changed at 88.44 yen JPY=.

Currency analysts at Citigroup Inc. said in a note a sharp shift in positioning and a decisive move higher in rate differentials in favor of the United States suggests dollar/yen is poised for an up move in the near term.

(Additional reporting by Lin Noueihed in London; Editing by Andrew Hay)

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