The euro rallied more than 1 percent against the dollar on Thursday after U.S. housing data and better-than-expected euro zone manufacturing and services activity revived appetite for risk.

The yen surrendered early gains versus the dollar and dropped sharply against other currencies as U.S. stocks gained, 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. The dollar received a boost (versus the yen) 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.

The euro EUR= was last up 1.2 percent at $1.2913, after hitting a session peak at $1.2933 on electronic trading platform EBS. It also gained 1.2 percent to 112.45 yen EURJPY=.

The dollar was flat at 87.06 yen JPY=, rebounding from a session low of 86.35, according to Reuters data.

U.S. existing home sales fell less sharply than expected to a three-month low in June, an industry group said.

Earlier, a survey showed the euro zone's private sector surged ahead this month, with both the services and manufacturing sectors seeing the pace of growth accelerate.

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 82.535 after slipping to a low 82.469.

Attention focused on the release of European bank stress test results, due at 1600 GMT on Friday although some sources said they may 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 market say the test results could be positive for the euro if they reveal no unpleasant surprises, but doubts linger over whether the checks are tough or transparent enough.

The market has certainly bought the rumour 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 Theodore d'Afflisio)

Ben Bernanke Wells fargo Versus