* Markets cautious that euro strength may concern ECB
* Could dip further before ECB meeting on Thursday
* Broader trend for further gains intact
By Julie Haviv
NEW YORK, Feb 6 (Reuters) - The euro dropped against the dollar and yen on Wednesday as investors opted to book profits after weeks of sharp gains ahead of a European Central Bank meeting that could dictate the direction of the currency.
The euro should continue to fall if ECB President Mario Draghi, during a press conference following the central bank’s monthly policy-setting meeting on Thursday, raise concerns about the recent swift and sharp rise of the currency.
If Draghi comments on the potentially harmful impact of a stronger euro, it could be seen by the market as a kind of verbal intervention, but most believe he will avoid commenting on the currency.
Draghi is expected to recognize an improvement in the euro zone outlook and in market sentiment while acknowledging the region still faces many hurdles.
Supportive comments from Draghi last month helped set the stage for a sharp euro rally this year, lifting it to a 14-month high against the dollar, a 34-month peak against the yen and 15-month top to sterling.
“We expected euro/dollar to remain in tight ranges this whole week ahead of the ECB, which is what we have seen,” said John Doyle, foreign exchange strategist at Tempus Consulting in Washington, D.C.
Thursday “could be eventful, especially if the ECB hints at a future interest rate cut in the coming months,” he said.
Political uncertainty in Spain and Italy has given the euro a slightly bearish tone over the past few days, but the euro zone’s economy is showing signs of improvement, which diminishes chances of another ECB rate cut.
The ECB is expected to leave interest rates on hold.
“Like most, we do not expect the central bank to change their current policy tomorrow,” he said.
The euro pared losses on comments by German government spokesman Steffen Seibert, who said the euro was not over-valued and that long-term competitiveness could not be achieved via exchange rates.
The euro last traded at $1.3518, down 0.5 percent on the day and below last week’s peak of $1.3711, its highest since November 2011.
Against the yen the euro was down 0.8 percent at 126.18 yen, off a 34-month peak of 127.69 touched in Asian trade, with the yen remaining under selling pressure on expectations of aggressive monetary easing in Japan.
French President Francois Hollande called on Tuesday for a target exchange rate to protect the currency from “irrational movements”, although the idea ran into immediate opposition from Germany.
Analysts at Deutsche Bank said they were “turning more neutral” on euro/dollar, though they still expect a $1.35-$1.40 range for the rest of the first quarter.
The euro is up 2.4 percent against the dollar for the year to date.
The dollar was last at 93.34 yen, down 0.3 percent on the day, according to Reuters data. The dollar reached a peak of 94.06 in Asian trade, its highest since May 2010.
News on Tuesday that current Bank of Japan Governor Masaaki Shirakawa will step down three weeks earlier than planned spurred the latest bout of yen selling.
“The yen seems to be a one way train,” said Tempus’ Doyle. “We try to remind our clients how overvalued the yen has been for the past few years and was due for a major revaluation.”
“Trying to pick the yen’s bottom has been a dangerous endeavor, but I am staying short yen and will look to take profit again above 94,” he said.
Japanese Prime Minister Shinzo Abe, who has put the BOJ under pressure to do more to spur the economy, has made it clear he wants a governor who will be bold in easing monetary policy.
“As far as Japan is concerned they are exceeding market expectations with the pace of policy implementation and that’s going to keep the yen under pressure,” said Ian Stannard, European head of FX strategy at Morgan Stanley in London.
He said Morgan Stanley’s first-quarter forecast of 95 yen was likely to be exceeded, and a test of 98 to 100 yen was within reach.