NEW YORK (Reuters) - The euro rallied to a three-week high against the dollar on Friday, heading for its second straight week of gains, on hopes that Greece's lenders were nearing an agreement to release further aid to help the debt-stricken country.
A rise in German business morale also boosted the euro, although analysts said any euro strength should be limited given the bleak economic outlook for the euro zone as a whole and expectations that the European Central Bank will have to ease policy further.
Greece said the International Monetary Fund had relaxed its debt-cutting target for the country, suggesting lenders were closer to a deal for a vital aid tranche to be disbursed. But other sources involved in the talks cautioned the funding gap was far bigger than Greece has suggested.
"While we wouldn't want to understate the challenges of reaching agreement on Greece, news reports have described some of the remaining obstacles as technical and legal, and thus the hurdles to a deal do not seem insurmountable," said Nick Bennenbroek, head of currency strategy at Wells Fargo in New York.
The euro rose as high as $1.2991 on Reuters data, breaking above resistance at $1.2910, its 55-day moving average. It was last trading at $1.2971, up 0.7 percent on the day. For the week, the euro gained 1.8 percent, the best weekly performance since mid-September.
The euro also hit a seven-month high of 106.97 yen and was last at 106.92 yen, up 0.6 percent.
Euro zone finance ministers, the IMF and ECB failed earlier this week to agree on how to get Greek debt down to a manageable level and will have a third go at resolving the issue on Monday.
Euro zone finance ministers will also hold a teleconference on Saturday to prepare for Monday's meeting, officials said.
The euro has gained 2 percent against the dollar in the past two weeks as yields on Greek bonds fell on expectations that euro zone ministers should be able to sign off on another tranche of aid for Greece on Monday.
German business morale surprised with its first rise in seven months in November. The Munich-based Ifo think tank said its business climate index rose to 101.4 from 100.0 in October, far surpassing even the highest estimate in a Reuters poll.
"The IFO was a bit of surprise, but these are levels which we saw back in October and not really a turn in sentiment," Stuart Frost, fund manager at RWC Partners. "We expect the euro's gains to fizzle out."
YEN CARRY TRADES?
The dollar was little changed at 82.43 yen, pulling away from Thursday's high of 82.82 yen, its strongest level since early April. On the week, the dollar rose 1.2 percent.
The dollar has climbed nearly 4 percent against the yen in the last two weeks, with the yen weakened by expectations that a likely new Japanese government after an election scheduled for December would push the Bank of Japan to implement more drastic monetary stimulus.
Shinzo Abe, the leader of Japan's opposition Liberal Democratic Party, which is tipped to win the election, has called for measures such as having the BOJ buy bonds issued specifically to fund public works projects and pushing short-term interest rates below zero.
His party's policy platform calls for a 2 percent inflation target, and seeks to ensure that the BOJ will pursue it vigorously with a possible revision to legislation that guarantees the central bank's independence.
In an interview with the Wall Street Journal published on Friday, Abe was also quoted as saying that he would consider postponing sales tax increases agreed in August if the economy remained mired in deflation.
Analysts said loose monetary measures along with lax fiscal policies could keep the yen under pressure and could see yen-funded carry trades return. Under these trades, investors sell the low-interest rate yen to buy higher-yielding assets.
"Speculation is already growing that the yen will be the funding currency of choice for 2013 carry trades - a view we tend to support," Chris Turner, head of FX strategy at ING, said in a note.
A broad rally in risky assets such as stocks weighed down the safe-haven U.S. dollar. The dollar index slipped 0.9 percent to 80.226, after hitting a three-week low.