* Euro dips, some see its recent rise as overdone
* U.S. budget talks main focus in year-end trades
* Dollar steady after hitting 2-year high vs yen
* Currency moves volatile due to thin liquidity
By Gertrude Chavez-Dreyfuss
NEW YORK, Dec 28 (Reuters) - The euro fell against the dollar and yen on Friday as investors locked in recent gains, although it could trim losses if progress is made toward a last-minute deal on U.S. budget talks to avert tax hikes and spending cuts next year.
An agreement on the U.S. budget would be viewed as positive for riskier currencies such as the euro and Australian dollar, while a deadlock or snags in fiscal negotiations to avoid a “fiscal cliff” is deemed positive for the safe-haven and highly liquid dollar.
President Barack Obama and U.S. lawmakers are making a last-ditch attempt to revive stalled budget talks, days before a New Year’s deadline. Obama and Vice President Joe Biden will meet congressional leaders from both parties at the White House later on Friday.
Positive sentiment on the fiscal cliff meeting did not last long, however, said Boris Schlossberg, managing director of FX strategy, at BK Asset Management in New York.
“Prices have become so overbought that there was little enthusiasm to rally further. Once the selling began, it quickly triggered stops across the board, taking euro/dollar below the $1.3200 level and dollar/yen below 86.00.”
The euro was down 0.2 percent on the day at $1.3210, having slipped to a session low of $1.3164 when traders said it broke below stop loss sell orders around $1.3170.
Although analysts partly attributed the euro’s drop to year-end dollar demand and thin liquidity, they said unwinding of long euro positions also weighed on the currency.
The euro has made rapid strides since mid-November, gaining around 5 percent in a month to hit an 8-1/2 month high of $1.33085 on Dec. 19 as worries around the euro zone crisis ebbed.
“There is still a good chunk of scepticism among market participants about the euro being significantly higher than the $1.32-$1.33 level,” said Ulrich Leuchtmann, head of FX research at Commerzbank.
“Speculative market participants are not very happy with these levels and look at it as a good opportunity to sell the euro which is leading to the rapid drop in euro/dollar.”
The euro’s falls helped the dollar rise to a two-week high against a basket of currencies, with its index rising to 79.93.
The euro also reversed earlier gains against the yen to trade down 0.3 percent at 113.68 yen, having earlier hit a 17-month low of 114.675 yen as expectations of more monetary stimulus continued to pressure the Japanese currency.
The dollar was steady against the yen at 86.07 yen, edging away from an earlier peak of 86.64 yen, its strongest since August 2010, when it stopped just shy of reported options barriers at 86.75 yen and 87.00 yen.
Expectations that the new Japanese government will push the Bank of Japan to ease monetary policy further have weighed broadly on the yen and analysts say it could fall further.
The yen’s unabated slide since Shinzo Abe took the helm as Japan’s prime minister on Wednesday has hit fresh two-year lows for three straight days. Abe has vowed to press for aggressive monetary stimulus to fight deflation.
“Clearly there is some momentum in dollar/yen on expectations the BOJ will become more expansionary and this is currently weighing on the yen,” said Marcus Hettinger, global FX strategist at Credit Suisse.
The yen has fallen more than 10.6 percent against the dollar in 2012, putting it on track for its biggest annual percentage drop since 2005.
The dollar looked set to end the week above its 200-week moving average, now around 84.95 yen, for the first time since late December 2007, a technical signal indicating further gains.