* Euro holds gains after riding on short-squeeze rally
* ECB wrong foots euro bears with optimistic comments
* Sterling off lows, BOE surprises some with no action
* China trade data, U.S. payrolls next event risks
By Ian Chua
SYDNEY, March 8 The euro held onto gains early in Asia on Friday, having posted its second biggest one-day rally this year, after the European Central Bank wrong footed investors who had positioned for a more dovish signal from ECB President Mario Draghi.
In contrast, the yen wallowed at a 3-1/2-year low as markets looked past the Bank of Japan's steady policy decision on Thursday to the April meeting, where new leaders are expected to take bolder action to defeat deflation.
The euro was at $1.3107, not far from a high of $1.3119 set overnight, after Draghi played down the threat of contagion to other euro members stemming from a political stalemate in Italy.
He also sounded upbeat on the outlook, saying there are many signs that market confidence in the euro area is returning, suggesting the bank is in no mood to act any time soon.
Draghi's comments prompted euro bears to quickly cover short positions, lifting the common currency by more than 1 percent on Thursday in its best performance since early January.
Against the yen, the euro boasted an even more impressive rally of nearly 2 percent to 124.57, pulling well away from last week's 118.74. The move has brought the 34-month peak of 127.71 set last month back in play.
Traders, however, suspect further gains will be limited for now as the market turns its focus to Chinese trade data and the influential U.S. non-farm payrolls report.
"The U.S. non-farm payrolls report will be the biggest event risk over the next 24-hours of trading and the data may increase the appeal of the dollar as job growth is expected to pick up in February," said David Song, currency analyst at DailyFX.
Economists polled by Reuters expect the U.S. economy to have created a net 160,000 jobs in February and the unemployment rate to remain at 7.9 percent.
The rebound in the euro saw the dollar index beat a hasty retreat to 82.084, from a 6-1/2 month high of 82.604 set on Wednesday. Versus the yen, the dollar stayed near a 3-1/2-year high around 95.10 struck overnight.
Investors say action is likely to come at the BOJ's next meeting on April 3-4, when Haruhiko Kuroda, a vocal advocate of aggressive easing, is expected to have taken over as governor.
Sterling firmed a touch to $1.5015 after the Bank of England held fire on more economic stimulus, but it was still precariously close to a 2-1/2 year trough of $1.4965.
Down one day and up the next, commodity currencies extended their choppy trading pattern seen in the past few sessions. The Australian dollar rose back towards $1.0300 from $1.0219 but broke no new ground. It appeared to have carved out a $1.0100-$1.0350 range for now.