* Focus on Fed policy meeting next week * Dollar surrenders gains vs yen, but bids seen at 103 yen * Tight liquidity helps euro; banks to repay LTRO cash early * Swiss franc hits 30-year high vs yen By Gertrude Chavez-Dreyfuss NEW YORK, Dec 13 (Reuters) - The dollar rose for a second straight session against the euro on Friday, as investors began pricing in the possibility that the U.S. Federal Reserve could announce a small reduction in its massive stimulus at next week's meeting. While market participants in general expect the Fed to start paring back its stimulus no later than March, a growing number expect a reduction in the Fed's asset purchases may be announced at the central bank's Dec. 17-18 policy gathering. "The bond market and, increasingly, the dollar, are beginning to price in a higher risk of a modest move by the Fed next week," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington. Esiner cited Thursday's strong U.S. retail sales number and this week's budget agreement in Washington, which removed the risk of another showdown over government spending early next year. "The budget deal greatly reduced the fiscal headwinds cited by Fed officials in the past as a hurdle to the removal of monetary accommodation," he added. Europe's economy, in contrast, remained sluggish compared to that of the United States. Thursday's soft euro zone industrial output was a stark reminder of the 17-member group's economic challenges and kept the risk of further easing from the European Central Bank on the table. In late New York trading, the euro fell 0.15 percent against the dollar to $1.3731. On the week, however, Europe's common currency was still up 0.2 percent, its best weekly gain since mid-November. The dollar index was just above the break-even point on the day at 80.214. Against the Swiss franc, the dollar edged up 0.1 percent to 0.8897 franc. The greenback gained against sterling, which fell 0.3 percent to $1.6296. The dollar, however, gave up its gains versus the yen after hitting five-year highs of 103.92 yen in Asian trading, its highest level since October 2008. In late New York activity, the dollar fell 0.20 percent at 103.15 yen. On the week, the dollar posted minor gains of just 0.2 percent against the yen, but it was the strongest weekly performance since early November. Marshall Gittler, head of global FX strategy at IronFX Global, who thinks the Fed will begin tapering next week, said he expects dollar/yen to reach 130 yen by the end of next year as Japan's economic struggles come to the fore. The euro also hit a five-year peak against the yen at 142.81, but was last down 0.35 percent at 141.64 yen. So far this year the dollar has gained 19 percent against the yen while the euro has risen 24 percent, on expectations the Bank of Japan will provide even more stimulus next year. The euro in general has been resilient despite recent poor economic data, as two-year swap rates rose to their highest levels in a month. The European Central Bank said on Friday banks will return 22.65 billion euros of crisis loans to it next week, above analysts' forecasts, tightening liquidity in the bloc. Citi strategist Valentin Marinov said this can help push the euro higher for now, but it isn't positive for the euro longer-term as tightening liquidity hits lending and growth. YEN RECOVERS The yen earlier slumped to a three-decade low against the Swiss franc, with some attributing the broad-based decline to a resumption of its role as a conduit for carry trades, given the Japanese central bank's continued commitment to an ultra-easy monetary policy. The franc has been buoyed by Swiss banks repatriating money before the year-end. The Swiss franc rose to 116.68 yen , its highest level since early 1983 in Asian trading. But in the New York session, the Swiss franc has retraced its gains to trade 0.25 percent lower to 115.91 yen.